The Delaware Supreme Court today, in the case of Americas Mining Corp. v. Theriault, No. 29, 2012 (Del. Aug. 27, 2012), read here, in a 110-page opinion, upheld the Court of Chancery’s 100-plus page decision awarding over $2 billion in damages based on a breach of fiduciary duty claim in connection with the sale of a company. Delaware’s High Court also upheld an award of attorneys’ fees in the amount of $300 million. The trial court decision, styled as In re Southern Peru Copper Corporation Shareholder Derivative Litigation, C.A. No. 961-CS (Del. Ch. Oct. 14, 2011), was highlighted on these pages here and here.

Prof. Paul L. Regan provides scholarly commentary and practical insights here. For example, regarding the shifting of the burden of proof that may apply if a special committee is truly independent, the good professor observed that the Supreme Court in this opinion:

clarified in such cases going forward that the burden of persuasion would remain “with the defendants throughout the trial to show the entire fairness of the interested transaction.”  In this regard, the Supreme Court’s ruling is likely in keeping with the advice of counsel to controlling stockholders in such cases already, i.e., establish a special committee process that is unassailable but prepare for trial as if the burden of proof remains on the defendants.  For transaction planners and litigation counsel alike, Southern Peru appropriately reinforces the practical reality that defendants in these cases need to protect the transaction with good process irrespective of whether they get the burden shift before, at or after trial.

Professor Stephen Bainbridge provides expert analysis about the case here, including discussion of the burden of proof issue.  The Wall Street Journal’s Law Blog wrote about the case here.

UPDATE: On Sept. 21, 2012, the Supreme Court denied a motion for reargument. Delaware’s High Court rejected the argument in the motion that because the 81% majority shareholder would be “paying itself” the amount of the derivative judgment, the amount of the attorneys’ fees should not include its proportionate interest. The Court explained that no stockholder has a claim to any assets of the corporation. A derivative award is for the benefit of the corporation. Slip op. at 114. The Court refused to treat this derivative award as if it were a class action for the benefit of minority shareholders only.

Supplement:

In addition to the foregoing scholarly insights, I provide the following bullet points with key statements of important principles from the opinion about Delaware law on topics that Delaware practitioners will have frequent need to refer to in corporate and commercial litigation matters:

  • Scheduling orders: Delaware’s High Court underscored the well-settled Delaware truism that these have the “same force and effect as court orders” and any request to change them is “entrusted to a trial judge’s discretion”. Slip op. at 52-53. The eleventh-hour request to modify long-standing trial dates would have been unfair to the plaintiff and the record supports the trial court’s decision based on a logical deductive reasoning process.
  • Burden Shifting: When a transaction involving self-dealing by a controlling shareholder is challenged, “the applicable standard of judicial review is entire fairness, with the defendants having the burden of persuasion. In other words, the defendants have the burden of proving that the transaction with the controlling stockholder was entirely fair to the minority stockholders.” See footnote 17 and accompanying text.
  • Two ways to shift that burden are: First, demonstrating that the transaction was approved by a “well-functioning committee of independent directors; or second, … that the transaction was approved by an informed vote of a majority of the minority shareholders.”  (citing Kahn v. Lynch Commc’n Sys., Inc., 638 A.2d 1110, 1117 (Del. 1994)).
  • Lynch and its progeny set forth what is required in order for an independent committee to obtain a burden shift. See footnotes 28 to 35. In this case it did not matter, as noone could have met the burden. The trial court observed that “it was not stuck in equipoise” about the issue of fairness, and found that the deal was unfair regardless of who had the burden. Although the members of the special committee were independent and well-qualified, the Court explained why how they “fell victim to a controlled mindset and allowed Grupo Mexico to dictate the terms and structure of the Merger.” Slip op. at 68.
  • Damages for breach of the duty of loyalty: The Court acknowledged Chancery’s broad powers generally to fashion “custom-made” relief, and in particular when it comes to awarding damages for breach of the duty of loyalty, it has even greater discretion. See footnotes 64 – 66 and accompanying text.
  • Attorneys’ Fees in Contingency/Derivative cases: The Court interpreted the reasonableness requirement of Rule 1.5(c) of the Rules of Professional Conduct to allow contingency fees that may have the net effect of translating into “very high” hourly rates. (In this case, the hourly rate computed to about $35,000 per hour.)  Slip op. at 86. The Court also described the historical underpinnings of the “common fund doctrine” as a well-established basis to award fees in representative litigation. See footnotes 70 to 73. The Court discussed and applied the standards outlined in Sugarland Indus., Inc. v. Thomas, 420 A2d 142, 149-50 (Del. 1980). 
  • No Cap on Amount of Fees. Importantly, Delaware’s High Court ruled that: “we decline to impose either a cap or the mandatory use of any particular range of percentages for determining attorneys’ fees in megafund cases.”  Slip op. at 105. The reasoning in part was due to an unwillingness to limit Chancery’s capacious authority to fashion remedies and award fees with “new mechanical guidelines.”. See footnote 125 and accompanying text.

Policemen’s Annuity and Benefit Fund of Chicago v. DV Realty Advisors LLC, C.A. No. 7204-VCN (Del. Ch. Aug. 16, 2012).

Issue Addressed: How to define “good faith” for purposes of a limited partnership agreement that required a good faith determination for removal of a general partner.
Short Answer: The Court compared the common law definitions of good faith in the fiduciary context as compared to contract law, and also referred to the definition in the Uniform Commercial Code.  See Slip op. at 33 and 34, and footnote 101.

Background

This Delaware Court of Chancery opinion involved the governing document of a limited partnership which was styled as the Third Amended and Restated Agreement of Limited Partnership (the “LPA”).  The LPA provided a mechanism by which the limited partners could remove the two co-general partners without cause.  The limited partners in this case sought a declaration that their removal of the managing partner/general partner was valid.

Legal Analysis

The Court begins its analysis by observing that in a declaratory judgment action, the plaintiff has the burden of proof.  The Court collects and discusses a useful number of important cases involving those situations when the Court will impose an implied obligation of reasonableness to temper the discretion that an agreement may give to a party to make a decision or perform an action pursuant to the terms of an agreement–when that discretion is not already clearly defined.  See Slip op. at 28 to 31.

The parts of this 56-page opinion that are likely to be of the most wide-ranging interest for most readers, include the discussions regarding the common law definitions of good faith in the context of both contract law and fiduciary duty law.  See Slip op. at 33 to 34.

For purposes of contract law, the Court referred to the definition in the UCC found at 6 Del. C. Section 1-201(20), which applies to contracts involving “goods” and defines good faith as follows:  “Except as otherwise provided in Article 5 [which deals with letters of credit], [good faith] means honesty in fact and the observance of reasonable commercial standards of fair dealing.”  See Slip op. at 35.

In this case, the contract did not define good faith and thus the Court presumed that the parties intended to adopt the common law definition of good faith as applied to contracts, which the Court described as “primarily subjective, but there is likely some conduct which is so unreasonable that this Court will necessarily determine that it could not have been undertaken in good faith.  That may be because the common law definition of good faith as applied to contracts contains an objective element or it may be that, regardless of the evidence presented as to subjective intent, the Court will necessarily (almost always) find that certain conduct cannot possibly have been undertaken in good faith.  Articulating with precision what specific conduct will fall into this category is not possible.  Context matters – – what is utterly unreasonable in one setting may be perfectly acceptable in another.”  See footnote 105 and accompanying text. 

The Court found that the conduct of the limited partners in this case did not approach the sort of unreasonable conduct that is necessarily undertaken in bad faith.  The Court also recognized that some test is required and conduct must be analyzed under some rubric, and for that purpose the Court referred to the aforementioned UCC definition, which the limited partners in this case satisfied.

The Court described in extensive detail why it found that the limited partners satisfied the standard of good faith in their decision to remove the managing partner/general partner of the limited partnership without cause.  The Court explained that the continuous failure of the managing partner to provide the audited financial statements by the deadline required in the agreement was sufficient to provide the limited partners with a good faith belief that the managing partner/general partner needed to be removed for the best interest of the limited partnership.

Central Mortgage Company v. Morgan Stanley Mortgage Capital Holdings LLC, C.A. No. 5140-CS (Del. Ch. Aug. 7, 2012).  This Court of Chancery decision was the result of remand from a decision of the Delaware Supreme Court which was highlighted on these pages here, and which clarified the standard in Delaware for the review by the Court of a motion to dismiss under Rule 12(b)(6) – which the Delaware Supreme Court made clear is not the same as the standard applied based on federal rule of civil procedure 12(b)(6)–even though the Delaware rules of civil procedure are based on the federal rules.  See Cent. Mort. Co. v. Morgan Stanley Mort. Capital Holdings LLC, 27 A.3d 531, 541 (Del. 2011) [hereinafter Central Mortgage II.]

A key issue in this case dealt with those situations in which a amendment to a complaint will relate back to the original complaint for purposes of a statute of limitations analsyis. After remand, the plaintiffs amended their complaint to add new breach of contract and implied covenant claims.

The Court of Chancery explained that the “law of the case” doctrine, and the Delaware Supreme Court opinion left no room to “re-dismiss” the original theories contained in the original complaint that was the subject of a prior appeal.  However, the Court did grant the motion to dismiss the new claims that were included in an amended complaint after the remand, based on the Delaware statute of limitations.

Gould v. Gould, C.A. No. 3332-VCP (Del. Ch. Aug. 14, 2012).  This 38-page decision addressed issues that arose in connection with the dissolution of an LLC, and in particular, disputes that arose regarding the sale of assets of the LLC, which sale was overseen by a trustee appointed by the Court for the dissolution and winding up of the LLC.

Mich II Holdings LLC v. Schron, C.A. No. 6840-VCP (Del. Ch. Aug. 7, 2012). A prior Chancery decision in this case was highlighted on these pages here.

Issue Addressed: Whether the standard for a motion for reargument under Rule 59(f) was satisfied.

 Short Answer: Only in part.

Brief Overview: This is one of those rare cases where a motion for reargument under Court of Chancery Rule 59(f) is granted, even if it was only granted in part.  Another noteworthy aspect of this case is that it was a joint motion for both reconsideration under Rule 59(f), as well as a motion seeking certification of an interlocutory appeal pursuant to Supreme Court Rule 42.  The latter motion for certification was denied.  The limited portion of the motion for reconsideration that was granted was based, according to the Court, on “plaintiffs’ refusal to pursue the escrow claim in New York.” [in which a related case was pending.] The Court described that strategy as a rejection by the plaintiff of the suggestion by the Court that they pursue their escrow claim in New York where most of the claims were initially brought.  This may be a useful opinion to consult when addressing a motion for reconsideration. [See prior case summary.]

 

 

 

 

Viacom International, Inc. v. Winshall, C.A. No. 7149-CS (Del. Ch. Aug. 9, 2012).

Issue: Whether the decision of an expert (as opposed to a conventional arbitrator) chosen in the merger agreement to decide earn-out dispute should be treated as an arbitration award, and vacated based on the Federal Arbitration Act?  Short Answer: No.

Background

This Court of Chancery opinion involved an earn-out dispute resulting from an acquisition by Viacom.  The parties provided in their merger agreement that the amount of the earn-out would be determined pursuant to an alternative dispute resolution procedure that submitted the issue to a binding decision by an accountant (as opposed to a law-trained arbitrator).  Viacom challenged the determination of the accountant.  Even though the decision of the accountant was binding, Viacom challenged it based on the standards outlined in the Federal Arbitration Act (“FAA”). Moreover, a related issue is whether the Court could even consider the matter or whether it was a dispute that needed to be decided by the person chosen to make the initial decision pursuant to the agreement.  That person determined that Viacom owed approximately $300 million pursuant to the earn-out provisions of the merger agreement.  This Court of Chancery decision upheld that determination or, in other words, refused to vacate the $300 million award of the accountant.

Legal Analysis

The Court discussed first the sub-issues of “substantive arbitrability” and “procedural arbitrability”, and whether or not the Court should even address the issue presented to it.  See footnotes 91 to 94.  Another formulation of the issues was whether the determination, pursuant to the merger agreement by the selected accountant, was within the authority granted by the merger agreement to the accountant for determination of those issues.  Secondly, the Court turned to whether or not there was a sufficient basis under the FAA to vacate that determination. In essence, the Court rejected all of Viacom’s arguments.

The Court observed that the standard of review under the FAA when a Court reviews an arbitration award is “one of the narrowest standards of review in all of American jurisprudence.”  See footnotes 81 to 86. The limited scope of review only allows for a successful challenged when arbitration awards have been procured by fraud, or when the arbitrators were clearly guilty of misconduct, or when the arbitrators exceeded their powers.  See slip op. at 25. See also 9 U.S.C. Sections 10(a)(3), (4).

Also useful to note is the citation to a U.S. Supreme Court decision for the statement of law that:  “The scope of judicial review of an arbitration award under the FAA cannot be expanded by contract.”  See footnote 80.

The Court flatly rejected the argument that “experts” who serve the role of arbitrators pursuant to a private resolution agreement should be treated differently for purposes of review than a law-trained arbitrator. The Court cited to cases acknowledging that when a private resolution procedure is provided for by agreement, even when those disputes are referred to a “expert” as opposed to an “arbitrator” as a decision maker, (such as an accountant), those proceedings will be treated as an arbitration for purposes of judicial review.  See footnote 78 and federal as well as Delaware cases cited therein.

The opinion provides cites to several decisions of the Court of Chancery that address whether post-closing earn-out procedural issues should be decided by a Court or by an arbitrator, but acknowledged that those decisions regarding arbitrability issues are not easily reconciled.  See footnotes 107 and 108 and accompanying text.

Also useful for practitioners is the opinion’s notable reference to the applicability of the FAA to arbitration agreements in Delaware unless the agreements specifically require or seek the application of the Delaware Uniform Arbitration Act (“DUAA”).  See footnote 109 (referring to recent amendment of 10 Del. C. Section 5702(a), (c) (2009) which provides that the FAA  applies to arbitration agreements that do not specifically state that the parties desire the DUAA to govern.)  This recent DUAA amendment reflects the desire of the state to promote certainty and efficiency for parties choosing arbitration.

The Court also observed that:  “The game of arbitrator-judicial badminton that Viacom’s argument would promote is, in practical effect, inconsistent with the pro-efficiency objective of Delaware statutory law.”

The final footnote of the opinion contains a citation to a practical decision that may be of relevance to those who toil in the fields of commercial litigation.  See footnote 131 (citing to Court of Chancery decision for the position of Delaware law that:  “There is no right to set-off of a possible, unliquidated liability against a liquidated claim that is due and payable.”)

In re Synthes, Inc. S’holder Litig., C.A. No. 6452-CS (Del. Ch. Aug. 17, 2012). This recent opinion by Chancellor Leo Strine, Jr. from the Court of Chancery includes a discussion of the contours of  fiduciary duties that were announced many years ago in the Delaware Supreme Court’s Revlon decision. Professor Stephen Bainbridge has already provided scholarly commentary in a piece he has entitled: Strine on the Borders of Revlon-land.

The good professor’s latest scholarship on the topic of duties under Revlon begins as follows (but deserves to be read in full):

My article The Geography of Revlon-Land (forthcoming 81 Fordham L Rev ___ (2013)), explains that when a target board of directors enters Revlon-land, the board’s role changes from that of “defenders of the corporate bastion to auctioneers charged with getting the best price for the stockholders at a sale of the company.”

A critical question then is to identify the check points at which target boards cross the border into Revlon-land. My article argues that a number of Chancery Court decisions in the last decade have erred by holding that certain cases fall within the borders of Revlon-land even though both binding Delaware Supreme Court precedents and sound policy argue that those cases do not do so.

He concludes that this most recent decision in the Synthes case, however, gets it right.

Supplement: Professor Larry Hamermesh, Director of the Institute of Delaware Corporate and Business Law of the Widener University Law School, provides insightful and learned commentary on this case at this link. Jim Hamilton provides additional analysis here.

Further Supplement: Now that the scholars have weighed in, I provide a more conventional summary of the case for practioners, with a cursory background that highlights those aspects of the opinion that may be of the most practical application to the practitioner, especially regarding the duties of a controlling shareholder.

Issue Addressed: Whether the controlling stockholder breached its fiduciary duty by refusing to consider an acquisition offer that would have cashed-out all the minority stockholders of Synthes, Inc., but required the controlling stockholder to remain as an investor in Synthes.

Short Answer: No.

Background

The plaintiffs complained that because the controller did not give a consortium of private equity buyers a chance to make an all-cash offer, and ultimately accepted a bid by Johnson & Johnson for 65% stock and 35% cash, that the controlling stockholder breached his fiduciary duty to the minority stockholders.  In this 46-page opinion the Court rejected the arguments of the plaintiffs on multiple levels.

Analysis

This case provides a helpful recitation of Delaware law on the duties of controlling shareholders.  For example, the Court observes that self-sacrifice is not required.  Although the controlling shareholder of the company is entitled to a premium for his shares, the controlling shareholder in this case shared that premium with all other shareholders.

The Court explained why the Revlon duties were not triggered, in part because 65% of the acquisition price was for stock in a AAA-rated public company which itself had no controlling stockholder, but rather, control in which was diversified throughout a “large, fluid, changeable and changing market.”

The legal analysis of the Court includes some of the more well-known Delaware decisions that form part of the bedrock of Delaware corporate law in connection with the duties of directors.

As a preliminary matter, in the context of a motion to dismiss, the Court observed that because the directors on the board were protected by DGCL Section 102(b)(7), which provision in their charter exculpated them from personal liability stemming from breach of the duty of care, the complaint must be dismissed against the directors unless the plaintiffs have successfully pled non-exculpated claims for breach of the duty of loyalty against them.  See footnotes 54 and 55. 

The Court underscored the core tenet of Delaware corporate law that:  “The directors of a corporation are presumed to have acted independently, with due care, and good faith and in the honest belief that their actions were in the stockholders’ best interest.”  See footnote 56. 

Among the traditional ways of rebutting the presumption of the business judgment rule that the board is entitled to, is for a plaintiff to allege that the merger transaction was an interested one in which the corporation was on the wrong side of the table from its majority stockholder.  However, when the merger involves a third party, the plaintiffs have sought to invoke the entire fairness standard by arguing that the controlling stockholder received materially different terms from the third party in the merger than the minority stockholders and that the third party merger should be subject to fairness review regardless of the fact that the controlling stockholder was not on both sides of the table.  See footnotes 58 to 59.  The argument in that context is based on the controlling shareholder exercising its power to cause the company to enter into a deal that is not equal to all stockholders and especially unfair to the minority because the controller allegedly diverted proceeds to itself that should have been shared equally among all stockholders.

In addition to rejecting the application of the entire fairness standard in this case, the Court explained in detail why the premise of those foregoing challenges was not supported by the facts of this case or the applicable law.

In explaining why Delaware law does not require, as part of the fiduciary duty of a controlling stockholder, to engage in self-sacrifice, for the benefit of minority shareholders, the Court explained that instead that duty is to:  “Put the best interests of the corporation and its shareholders above any interest not shared by the stockholders generally.”  See footnotes 86 and 87.  As explained by Chancellor Allen in Thorpe v. CERBCO, Inc., a controlling shareholder, “will not be allowed to use their control over corporate property for processees or procedures to exploit the minority, but are not required to act altruistically towards them.”  See footnote 89.

The discussion of why the Revlon standard does not apply has been ably addressed by Professors Bainbridge and Hamermesh on these pages and I recommend their discussion of that aspect of the Court’s opinion.

Huff Fund Inv. P’ship v. CKx Inc., C. A. No. 6844-VCG (Del. Ch.) (August 15, 2012).

Issue Presented:

In this appraisal action, is the relevance of the financial information of Fox Broadcasting, a non¬party to the litigation and the merger, regarding American Idol outweighed by the potential harm the disclosure of that information would cause for future contract negotiations?

Short Answer: Yes. The Court found that the marginal relevance of the internal Fox information is outweighed by the potential harm the disclosure of that information would cause Fox and the presence of non-confidential, more probative information already in the record.

Background:

In an appraisal action arising out of the merger between CKx and an affiliate of Apollo Global Management, LLC, Petitioners moved to enforce a subpoena issued to a non-party, Fox Broadcasting Company.  Fox has an existing agreement with a subsidiary of CKx, 19TV Limited, for the right to broadcast the American Idol television program, which provided substantial revenues to CKx before the Merger. The Petitioners wanted information related to American Idol, Fox’s contracts and contract negotiations with 19TV and FremantleMedia North American, and the merger. In particular, one request would require Fox to produce documents relating to Fox’s internal valuation and financial information regarding its negotiations with CKx in connection with an agreement to broadcast American Idol.

Parties Positions:

In opposing the subpoena, Fox argued that: (i) this information is of minimal relevance to an objective valuation of CKx’s stock given that the parties already know the actual, negotiated contract price (because it was executed in January 2012); (ii) the internal information is highly confidential and its disclosure would be harmful to Fox in future business dealings; and (iii) the requested information is overly broad and that its production would impose a significant expense on Fox, a burden particularly unjustifiable given Fox’s non-party status.

In support of the subpoena, the Petitioners argued that: (i) the amount Fox was subjectively willing to pay for American Idol broadcast rights is relevant to a valuation of CKx, as American Idol provided CKx with its largest source of revenue; (ii) confidentiality concerns can be addressed with a modification to the existing confidentiality order; and (iii) the potential burden on Fox is justifiable given that the requested information cannot be obtained from any other source.

Analysis:

The only litigable issue in an appraisal action is the value of the petitioner’s shares on the date of the merger. Weighing in favor of disclosure, the Court noted that there was some marginal relevance in the value Fox assigned to the contract. The Court noted that the value of the Petitioners’ shares on the date of the merger is dependent in part on the value of CKx’s rights in American Idol.  The Court went on to note that CKx’s and Fox’s subjective valuations—i.e., how much Fox was willing to pay and how much CKx was willing to take—would seem to establish a range within which an objective valuation might be located.  Weighing against the disclosure, the Court stated that in addition to the substantial expense Fox would incur in production, there is the potential harm the disclosure of that information would cause to Fox in future negotiations with CKx over American Idol broadcast rights if CKx were to learn precisely how Fox valued those rights in the past.  Moreover, the ability of a confidentiality order to prevent such harm is doubtful. CKx would have difficulty responding to the Petitioners’ arguments and characterizations regarding Fox’s valuations and internal information without access to the information itself.  Finally, the Court stated that superior information already exists regarding the objective value of CKx’s rights in American Idol—the actual agreement CKx reached with Fox in January 2012.

Motion to enforce subpoena denied.

The Office of the Register of Wills serves as the probate clerk for the Delaware Court of Chancery. Probate litigation is one of the “less well known” aspects of Chancery jurisdiction.

The Hon. Ciro Poppiti, III, Register of Wills for New Castle County, who is also a highly-regarded Delaware attorney, announced in a press release, that his office will begin e-filing as of December 1.  Probate cases are the sole remaining Chancery cases not being e-filed and this development is part of the Court’s goal to have its entire docket processed via e-filing.  Chancellor Leo Strine, Jr. lauded this initiative and commented that: “This effort represents another way that the Delaware courts strive to remain the best in the nation.”