Envo, Inc. v. Walters, C.A. No. 4156-VCP (Del. Ch. July 18, 2012).

Issue Presented: Whether promissory estoppel was established to impose personal liability in connection with the poorly documented sale of a business when the acquiring entity was never properly formed.

Short Answer: Yes.

Brief Overview

This 38-page post-trial decision involved an incompletely documented sale of a business and transfer of assets that were kept and used to run a business even though the entity named in the purchase agreement was never formed. The defendants had failed to pay for those assets even as of the date of trial.  This opinion describes in great detail the tortuous factual background and the less than complete documentation that was used to memorialize the sale of a small business, but the documents were never finalized.  Because of the relatively small amount involved for the purchase of this small business, the parties did not want to spend the unnecessary money for legal fees to properly “paper” the transaction.

Analysis 

The parts of this opinion that will be of the most widespread interest relate to the Court’s discussion of promissory estoppel, and its imposition of personal liability in connection with the use of an entity that was never properly formed.

Parenthetically, and initially, it is useful to highlight a procedurally unusual aspect of this case which involved one of the defendants disclosing for the first time after the trial started that he had relevant documents that he did not produce.  The penalty imposed by the Court for that unjustified late disclosure was to make those late-produced documents inadmissible.  The Court observed that it could not condone the failure of one of the defendants so belatedly producing those documents–that were clearly covered by at least two sets of document requests (one of which was almost three years earlier).

The explanation by the defendant was not accepted by the Court.  That excuse was that the defendant simply did not remember.  Moreover, the Court emphasized that the defendant presented no evidence that he or his counsel conducted an appropriate search for the responsive documents, and even though they admittedly knew about the documents before the trial, they failed to notify the Court and opposing counsel until after the trial started.

Latches and “Discovery Rule” for Statute of Limitations

The Court provided a helpful discussion of the concept of latches although it found that even if the Court did accept the proposition that the applicable statute of limitations was three years for the breach of a promise pursuant to 10 Del. C. § 8106, those claims would not be barred by latches because they were tolled under the “doctrine of inherently unknowable injuries.”  Sometimes referred to as the “discovery rule,” the doctrine of inherently unknowable injuries provides that a statute of limitations will not run “where it would be practically impossible for a plaintiff to discover the existence of a cause of action.”  See footnote 42.  In any event, the latches argument was rejected.

Promissory Estoppel 

The Court explained that under Delaware law, a plaintiff asserting a claim for promissory estoppel must show by clear and convincing evidence that:  (1) A promise was made; (2) The promisor reasonably expected to induce action or forebearance by the promisee; (3) The promisee reasonably relied on the promise and took action to his detriment; and (4) The promise is binding because injustice can be avoided only by its enforcement.  See footnote 59.  In addition, the promise must be reasonably definite and certain.  See footnote 60.

The Court carefully applied each of those elements in a discussion of the factual details as applied to the foregoing elements.

In part, the Court’s reasoning was that the assets of the business were used for years following the transaction and it would be inequitable, and would work an injustice, if the individual defendants and the new company were not held jointly and severably liable for failing to pay. The two individual defendants did not operate via an entity, therefore they would be treated by default as general partners who would each be liable for the obligations of the other. See 6 Del. C. Section 15-202(a).

Remedies

The Court explained that in awarding damages for promissory estoppel, whose primary purpose is to prevent injustice, the Court has the following options:  (1) It can do nothing; (2) It can grant restitution; (3) It can reimburse the promisee for the losses incurred by reliance; or (4) It can secure for the promisee the expectancy for its value.  See footnote 71 and 72.

The Court also found the individual defendants personally liable because the corporation was never formed as planned, so they could not limit their liability to a non-existent entity. The Court explained the details on which its reasoning was based and why the defendants could not limit liability to an entity that was not properly formed.

 Pre- and Post-Judgment Interest

The Court awarded both pre- and post-judgment interest, as well as costs under Court of Chancery Rule 54(d).  The post-judgment interest shall accrue at the legal rate pursuant to 6 Del. C. § 2301.  The Court used its discretion to reduce the rate of pre-judgment interest, although in Delaware pre-judgment interest is awarded as a matter of right, and the same is true of post-judgment interest.  See footnote 75.

Whittington v. Dragon Group LLC, C.A. No. 2291-VCP (Del. Ch. July 20, 2012).

Issue Addressed: Whether the Court should open the post-trial record to allow supplemental evidence, in order to reconsider the Court’s prior decision.

Short Answer: The Court mostly refused to reopen the record but partially granted the motion for reconsideration for a very limited purpose.

Background 

This is the latest iteration in a long series of decisions which the Court described as an ongoing saga between the plaintiff and the rest of his family who were members of the defendant LLC.  The Court introduced its latest decision as follows:  “Litigation between these parties has dragged on in some form or other for more than a decade, and, regrettably, this Letter Opinion is unlikely to be the last chapter.”  Many prior decisions in both the Delaware Supreme Court and Court of Chancery in this case have been highlighted on these pages and are available here.  Reference is made to those prior decisions for the extensive factual background.

Analysis

The Court observed that there is no express rule governing motions to open the evidentiary record after the close of evidence, but before the entry of a final judgment.  See footnote 15.  Instead, exercising its sound discretion, the Court can allow the introduction of additional evidence when doing so serves the interest of fairness and substantial justice.  The factors that the Delaware Courts consider in determining whether to grant a motion to reopen the record include:  (1) Whether the evidence has come to the moving party’s knowledge since the trial; (2) Whether the exercise of reasonable dilligence would have caused the moving party to discover the evidence for use at trial; (3) Whether the evidence is so material and relevant that it will likely change the outcome; (4) Whether the evidence is material and not merely cumulative; (5) Whether the moving party has made a timely motion; (6) Whether undue prejudice will inure to the non-moving party; (7) Considerations of judicial economy.

As part of its reasoning, the Court exhorted: “It is important that this litigation come to a final resolution soon.”

These guidelines for collaboration between Delaware counsel and non-Delaware lawyers were prepared by Francis G.X. Pileggi and Kevin F. Brady. 

This is a compilation of selected key Delaware court decisions, rules, and customs to guide Delaware attorneys serving as “Delaware Counsel” (or “local counsel”), and out-of-state attorneys admitted to practice in Delaware pro hac vice, or non-Delaware lawyers who collaborate on Delaware litigation with Delaware counsel.

The Role of Delaware Counsel

The Delaware Court of Chancery does not recognize the limited role of “local counsel” to the extent that it implies a less than plenary role of Delaware counsel—even if non-Delaware counsel are overseeing the litigation or taking the “laboring oar.”[i]  The Court of Chancery emphasizes that a Delaware attorney of record is responsible for every action taken by his or her client—from the content of the pleadings to the fulfillment of discovery obligations. “[T]he Delaware lawyer who appears in an action always remains responsible to the Court for the case and its presentation,” without reference to who drafted the document at issue or was responsible for certain actions.[ii] See generally, Principles of Professionalism for Delaware Lawyers.

The Court of Chancery has published Guidelines to Help Lawyers Practicing in the Court of Chancery, which make clear that the concept of “local counsel” does not exist in Delaware as a role with less than full responsibility. [iii] Those Guidelines provide in part as follows:

1. Role of Delaware Counsel

a. The concept of “local counsel” whose role is limited to administrative or ministerial matters has no place in the Court of Chancery. The Delaware lawyers who appear in a case are responsible to the Court for the case and its presentation.

b. If a Delaware lawyer signs a pleading, submits a brief, or signs a discovery request or response, it is the Delaware lawyer who is taking the positions set forth therein and making the representations to the Court. It does not matter whether the paper was initially or substantially drafted by a firm serving as “Of Counsel.”

c. The members of the Court recognize that Delaware counsel and forwarding counsel frequently allocate responsibility for work and that, in some cases, the allocation will be heavily weighted to forwarding counsel. The members of the Court recognize that forwarding counsel may have primary responsibility for a matter from the client’s perspective. This does not alter the Delaware lawyer’s responsibility for the positions taken and the presentation of the case.

d. Non-Delaware counsel shall not directly make filings or initiate contact with the Court, absent extraordinary circumstances. Such contact must be conducted by Delaware counsel.

e. It is not acceptable for a Delaware lawyer to submit a letter from forwarding counsel under a cover letter saying, in substance, “Here is a letter from my forwarding counsel.”

Former Chancellor William Chandler summarized the duties of “Delaware Counsel” in a recent interview, where he explained that Delaware attorneys have a duty to review all filings to make certain that the arguments and positions are consistent with Delaware’s rules and laws.[iv] The former chancellor also spoke about the obligation of Delaware attorneys to inform out-of-state counsel about Delaware courts’ customs and traditions.

Attorneys Admitted Pro Hac Vice

The Delaware courts also strictly regulate the pro hac vice admission of out-of-state attorneys, and the rules require a Delaware attorney moving the admission of an out-of-state attorney to determine and certify to the admitting court that the lawyer to be admitted is reputable and competent.[v] Out-of-state counsel also must certify that they have reviewed Delaware’s Principles of Professionalism for Delaware Lawyers. Even after being admitted to practice in Delaware pro hac vice, an out-of-state attorney may not (1) sign pleadings; (2) file documents with the Court;[vi] (3) communicate directly with the Court; or (4) attend proceedings without Delaware counsel (including calls with the court, mediation and arbitration proceedings), without express permission by the Court.[vii] However, out-of-state counsel who are admitted pro hac vice may take or defend depositions in the pending action without the presence of their Delaware counsel.[viii]

The fee for pro hac vice admission is assessed on an annual basis, and varies by court. The District of Delaware, which recently announced its “Pro Hac Vice Enhancements,” now allows District of Delaware registered CM/ECF users to pay the $25 annual fee for attorneys admitted pro hac vice through the Court’s electronic filing system.[ix]

An out-of-state attorney’s pro hac vice status may be revoked upon a motion to the Court.[x] Inappropriate conduct by out-of-state attorneys will not be tolerated by the courts, and can lead to revocation of an attorney’s pro hac status and submission of specific matters to the bar of the attorney’s home state as well as Delaware’s Office of Disciplinary Counsel.[xi] Examples of inappropriate conduct are provided below.

Delaware’s pro hac vice rules apply with equal force to Delaware-barred attorneys who do not maintain an office in Delaware. Maintaining an office in Delaware is a prerequisite to serving as an attorney of record in Delaware pursuant to Sup. Ct. R. 12(a)(i); if a Delaware attorney retires, or practices in another state, and his firm does not maintain a bona fide Delaware office, then that attorney will need to be admitted pro hac vice before filing documents with or arguing before any Delaware court.

The Delaware Supreme Court’s Office of Disciplinary Counsel compiled materials and case excerpts relevant to the practice of law in Delaware for attorneys admitted pro hac vice.[xii] These materials provide guidance on issues frequently encountered by Delaware counsel when assisting out-of-state counsel, as well as guidance for counsel admitted pro hac vice, including:

  • Out-of-state counsel’s desire to impermissibly limit the scope of retention of Delaware Counsel;
  • Identifying the client: distinguishing the underlying client in the litigation from out-of-state counsel who directs Delaware counsel and pays the bills;
  • Special consideration required when both Delaware counsel and out-of-state counsel are associated with the same firm, including the proper form of signature blocks; and
  • Procedures for Delaware-barred attorneys who practice out of state and do not maintain a bona fide Delaware office.

As a supplement to the extensive materials provided by the Office of Disciplinary Counsel, the following cases provide distinct examples of attorney conduct that will not be tolerated by the Delaware courts and how the courts address such conduct:

  • Sample v. Morgan, 935 A.2d 1046 (Del. Ch. 2007) (holding that a non-Delaware lawyer and her law firm could be sued in Delaware for providing advice and services to a Delaware corporation, its directors, and its managers on matters of Delaware corporate law, including the preparation of a certificate of incorporation, which they provided to a service agent to be filed in Delaware) (Ex. 12 hereto).
  • Beck v. Atl. Coast PLC, 868 A.2d 840 (Del. Ch. 2005) (sanctioning and fining out-of-state counsel under Rule 11 and Rule 37 for filing a deceptive complaint, improperly certifying that the plaintiff was fit to serve as class representative, and intentionally withholding relevant non-privileged documents responsive to discovery requests) (Ex. 13 hereto).
  • Auriga Capital Corp. v. Gatz Props., LLC, 2012 Del. Ch. LEXIS 19 (Del. Ch. Jan. 27, 2012) (shifting fees where plaintiff and his counsel acted in bad faith by “splatter[ing] the record with a series of legally and factually implausible assertions,” allowing defendant to collect responsive documents without legal supervision, and failing to preserve relevant documents and information) (Ex. 14 hereto).
  • Griffin v. The Sigma Alpha Mu Fraternity, C.A. No. 09C-04-067 JAP (Del. Super. Mar. 15, 2012) (imposing a $500 fine against plaintiffs for allowing out-of-state counsel, who was not admitted pro hac vice in Delaware, to conduct a deposition in a Delaware case) (Ex. 15 hereto).
  • In re Asbestos Litig. Limited to Ronald Carlton, C.A. No. 10C-08-216 ABS (Del. Super. May 14, 2012) (warning Delaware counsel of possible sanctions and/or rejection of documents filed for failure to adhere to the requirement that all correspondence to the Court be submitted on Delaware counsel’s letterhead and signed by Delaware counsel) (Ex. 16 hereto).

Electronic Discovery Duties

Electronic data preservation, collection, and production are also governed by the Delaware courts. Both the District of Delaware and the Court of Chancery provide guidelines on preserving electronically stored information (ESI) on their websites.

The District of Delaware implemented both a Default Standard for Discovery, Including Discovery of Electronically Stored Information[xiii] and a Default Standard for Access to Source Code.[xiv] These standards require counsel for all parties to confer on several topics concerning the production of ESI to avoid costly litigation of discovery disputes.

The Court of Chancery has adopted Guidelines for Preservation of Electronically Stored Information that require counsel to develop and oversee a process to preserve all relevant ESI.[xv] This process should include, at a minimum, identifying all custodians of potentially relevant information, disseminating litigation hold notices to those custodians, and conferring with opposing counsel to discuss whether they will limit or forgo discovery of ESI.

—          —          —

These guiding Delaware principles are further refined by the individual courts, each having its own rules for the admission of out-of-state attorneys, and the requirements of Delaware counsel. In addition, Delaware charges fees on an annual basis to renew a pro hac vice motion to enable out-of-state counsel to maintain his or her pro hac vice status in a particular case.

Because electronically stored information has created unique and unusual situations for lawyers and their clients in terms of discovery and trial, this topic is currently under review by many courts in Delaware.

**The exhibits referred to in this column are available by contacting the authors.

—————————————————————————————

[i]           State Line Ventures, LLC v. RBS Citizens, N.A., 2009 Del. Ch. LEXIS 233, at * 1 (Del. Ch. Dec. 2, 2009)

[ii]            Id.

[iii]          Delaware Court of Chancery, Guidelines to Help Lawyers Practicing in the Court of Chancery (2012), http://courts.state.de.us/Chancery/docs/CompleteGuidelines.pdf

[iv]          Francis G.X. Pileggi and Kevin F. Brady, Interview with Chancellor William Chandler from the Delaware Court of Chancery, Delaware Corporate & Commercial Litigation Blog (June 17, 2011), https://delawarelitigation.com/2011/06/articles/commentary/interview-with-chancellor-william-chandler-from-the-delaware-court-of-chancery/

[v]              Delaware Supreme Court and Delaware State Bar Association, Principles of Professionalism for Delaware Lawyers, at ¶ C (Nov. 1. 2003), http://courts.delaware.gov/forms/download.aspx?id=39428

[vi]          The Court of Chancery issued an Order to clarify that only members of the Delaware Bar can be signed up with the LexisNexis eFiling system as eFilers and to receive eFiling notifications by email. See Delaware Court of Chancery, Standing Order (Aug. 5, 2008) http://courts.delaware.gov/chancery/docs/ ChanceryStandingOrder_Out-Of-StateAttorneys_080408.pdf

The Court of Chancery also issued a Notice informing Delaware lawyers that it is a violation of Rule 79.1 to share their eFiling passwords or add non-Delaware lawyers to the electronic service list. See Francis G.X. Pileggi, Chancery Clarifies and Admonishes: eFiling Passwords for Delaware Lawyers Only, Delaware Corporate & Commercial Litigation Blog (May 6, 2008), https://www.delawarelitigation.com/2008/05/articles/ commentary/chancery-clarifies-and-admonishes-efiling-passwords-for-delaware-lawyers-only/

[vii]         See Andrea L. Rocanelli, Pro Hac Vice: Ethical Challenges of Serving as Delaware Counsel, Office of Disciplinary Counsel of the Delaware Supreme Court (Jan. 25, 2008), https://www.delawarelitigation.com/int86.PDF (citing Forte Capital Partners, LLC v. Bennett, Del. Ch., C.A. No. 1495-N (2005) (rejecting pleadings, motions, and letters to the Court signed by out-of-state counsel; also rejecting the appearance before Court in a teleconference by an attorney admitted pro hac vice when Delaware counsel was not present for the conference)). See also https://www.delawarelitigation.com/2008/01/articles/ commentary/delaware-litigation-via-pro-hac-vice-admissions/ (suggesting that Delaware lawyers provide these materials to out-of-state lawyers when asked or retained to serve as local counsel).

[viii]         See Griffin v. Sigma Alpha Mu Fraternity, 2012 Del. Super. LEXIS 119 (Del. Super. Ct. Mar. 15, 2012) (holding that out-of-state counsel is not permitted to question a deposition witness in a Delaware action—even if “supervised” by Delaware counsel—“unless, and until, counsel is admitted pro hac vice.”)

[ix]          United States District Court for the District of Delaware, Pro Hac Vice Enhancements (July 13, 2012), http://www.ded.uscourts.gov/pro-hac-vice

[x]           See State ex rel. Secretary of the DOT v. Mumford, 731 A.2d 831 (Del. Super. Ct. 1999) (revoking the pro hac vice admission of out-of-state attorney who “demonstrated a lack of civility and professionalism by ‘coaching the witnesses’ during the depositions, by failing to control or attempt to control the objectionable conduct of his client, and by encouraging the [inappropriate] conduct of his client.”)

[xi]          Manning v. Vellardita, 2012 Del. Ch. LEXIS 59 (Del. Ch. Mar. 28, 2012) (holding that while out-of-state attorney’s failure to fully disclose law firm affiliation “fell short of the level of candor this Court expects of attorneys practicing in Delaware,” there was no basis to revoke attorney’s pro hac vice status; however, Court referred the matter to the bar association of attorney’s home state and the Delaware Office of Disciplinary Counsel).

[xii]         See supra note 7.

[xiii]         United States District Court for the District of Delaware, The Default Standard for Discovery, Including Discovery of Electronically Stored Information (Dec. 8, 2011), http://www.ded.uscourts.gov/sites/default/files/Chambers/ SLR/Misc/EDiscov.pdf

[xiv]          United States District Court for the District of Delaware, The Default Standard for Access to Source Code (Dec. 8, 2011), http://www.ded.uscourts.gov/sites/ default/files/Chambers/SLR/Misc/DefStdAccess.pdf

[xv]          See Delaware Court of Chancery, Guidelines for Preservation of Electronically Stored Information (Jan. 18, 2011), http://courts.delaware.gov/forms/download.aspx?id=50988. See also Francis G.X. Pileggi, Delaware Court of Chancery Issues Non-Binding Guidelines to Help Lawyers Navigate Their Cases Through the Court More Efficiently, Delaware Corporate & Commercial Litigation Blog (Jan. 15, 2012), https://delawarelitigation.com/2012/01/ articles/chancery-court-updates/delaware-court-of-chancery-issues-non-binding-guidelines-to-help-lawyers-navigate-their-cases-through-the-court-more-efficiently/.

Among the important recent Delaware corporate and commercial decisions highlighted on these pages over the last few months, we compiled a few at the following links:  

Supreme Court Affirms Decision to Delay Hostile Offer Based on Violation of Confidentiality Agreement 

Court Awards $3.2 Million in Attorneys’ Fees in Contract Dispute

No Fiduciary Duty, Per Se, to Minimize Corporate Taxes, but Court Allows Claim of Excess Compensation for Board Members

Not Per Se Breach of Fiduciary Duty for a Board to Fail to Have a Succession Plan

Dismissal of One Derivative Lawsuit Not a Bar to Second Derivative Claim by Second Stockholder

Postscript:  Professor Bainbridge graciously linked to this post and we will be eternally grateful for the good professor’s kind observation that: “It’s these sort of updates that made Francis Pileggi’s blog must reading for all corporate lawyers.”

David v. Human Genome Sciences, Inc., C. A. No. 12-965-SLR (D. Del.) (July 26, 2012).

Issue Presented:

Did the plaintiffs, security holders of defendant Human Genome Sciences, Inc. (“HGSI”), meet their burden of proof for injunctive relief in order for investors in HGSI to have more time to consider whether to tender their shares?

Short Answer: No.  Motion Denied

Brief Overview:

In April 2012, GlaxoSmithKline plc (“GSK”) made an unsolicited offer for HGSI at $13 per share which was rejected by the Board.  On May 10, 2012, GSK initiated a hostile tender offer at $13 per share.  GSK extended its offer a couple of times and filed regular amendments to its SEC filings.  While HGSI management attempted to shop the company, there were no other interested bidders available.

On July 13, 2012, GSK and HGSI engaged in negotiations and reached an agreement at a price of $14.25 per share which the Board voted to recommend as fair to HGSI’s security holders.  On July 16, 2012, HGSI and GSK issued a joint press release announcing that GSK had amended its initial offer to increase the price to $14.25 per share and had extended the expiration date to July 27, 2012. HGSI also explained that its board had determined that the increased offer was in the best interests of the company and its security holders. On July 19, 2012, HGSI filed a further amendment to its 14D-9 containing its recommendation of the offer and its financial advisors’ opinions that the price was fair from a financial point of view to HGSI’s security holders.

Plaintiffs filed suit arguing not that there were misleading statements, insufficient disclosures or inaccurate representations, but rather that GSK’s tender offer should be extended “to give HGSI’s security holders sufficient time to digest the new tender offer price and the 180 degree change in HGSI’s position (from “do not tender” to “tender,” from unfair to fair).”   Plaintiffs also argued that the July 16 and July 19 disclosures should be treated as a new tender offer, and because the complexion of the tender offer was fundamentally altered when it changed from a hostile to a friendly offer.  Thus, the defendants had violated federal securities laws by attempting to consummate the tender offer in an impermissibly short time period, depriving HGSI’s security holders “of their right to make a fully informed decision regarding their shares”, and irreparable harm should be presumed if security holders are forced to tender their shares without adequate information or time for reflection.

Defendants argued that the July 16 and July 19 disclosures should not be characterized as a new tender offer but only a change in price and that they followed the tender offer rules and, therefore, plaintiffs cannot demonstrate a likelihood of success on the merits.

The Court agreed that defendants had complied with the technical requirements of the SEC’s tender offer rules.  In addition, in declining to “exercise its inherent equitable powers to extend the closing of the tender offer”, Judge Robinson noted:

Compliance with the regulations and interpretive guidelines promulgated by the SEC are deemed to be adequate, absent materially deficient disclosures…[and] courts are loathe to interfere in the dynamics of market transactions (again, absent materially deficient disclosures) because of the ‛risk that security holders will lose the opportunity to cash in their investment at a substantial premium.’

Distinguishing one of her prior decisions, Bally Gaming International, Inc. v. Alliance Gaming Corp., No. 95-538, 1995 WL 570643 (D. Del. Sept. 29, 1995) Judge Robinson found that the imposition of a temporary restraining order was not warranted where there was just an increase in the price offered and “nothing but speculation to support the proposition that HGSI’s security holders will have any difficulty digesting the reasoning behind management’s change of heart.

District v. Chancery  and “A Sign of the Times”

This District Court decision is unique in that there have not been very many decisions recently in the District of Delaware addressing equitable relief for mergers and acquisitions.  The Court of Chancery has cornered the market on that activity in Delaware.  While there are similarities in the practice before both courts, there are significant differences.  Judge Robinson’s opinion is only nine pages long (with five footnotes) which is a stark contrast to the length of opinions we are used to seeing regarding mergers and acquisitions in the Court of Chancery.  And apparently that difference was not lost on Judge Robinson when she stated in footnote No. 4 “[i]t is a sign of our litigious times that today, the single issue of a change in price (at issue) takes 80 pages to explain, while a host of issues could be explained (in Bally) with eight pages.”

In Re: Appraisal of Orchard Enterprises, Inc., C.A. No. 5713-CS (Del. Ch. July 18, 2012). 

Issue Addressed

In this post-trial decision in an appraisal action arising out of a merger, the Court determined the fair value of the shares, relying on the discounted cash flow method of valuation.

Brief Background

The common stockholders of The Orchard Enterprises, Inc. were cashed out at a price of $2.05 per share by Orchard’s controlling stockholder.  Relying on a discounted cash flow analysis (“DCF”), the petitioners claim that each common share was worth $5.42 as of the date of the merger.  By contrast, the respondent company contended that the merger price was generous and that the common shares were worth only $1.53 as of the date of the merger.  After trial, the Court determined that the fair value of the shares pursuant to Section 262(h) of the DGCL were worth $4.67 per share, which was supplemented with an award of interest at the statutory rate.

The Court observed that the largest disparity in the valuation approach of the experts was based on the differing treatment by the parties of a $25 million liquidation preference owed by Orchard in certain circumstances to the holders of its preferred stock.  Although Orchard admits that the liquidation preference was not triggered by the merger, Orchard argued that the liquidation preference must still be deducted from the enterprise value of Orchard before calculating the value of its common stock in this statutory appraisal.  The Court disagreed with that position as a matter of law and found that whether the liquidation preference would ever be triggered in the future was entirely a matter of speculation as of the date of the merger.  The liquidation preference was not the subject of a put right by contract at a certain date, but rather was only triggered by unpredictable events, such as a dissolution or a liquidation. 

Most importantly, the Court relied on settled Delaware law that the applicable standard entitled the petitioners to receive their pro rata share of the value of Orchard as a going concern, and not on a liquidated basis, and without regard to post-merger events.  See footnotes 6 through 9 (citing Cavalier Oil Corporation v. Harnett, 564 A.2d 1137, 1144 (Del. 1989); and Cede & Co. v. Technicolor, Inc., 684 A.2d 289, 298 (Del. 1996)).

The Court explained that the proper way to value the shares of the petitioner is to value Orchard as a going concern, and to allocate value to the preferred and common stock based on the allocation made in the Certificate of Designations.  The Court added that such an approach “marries perfectly with the DCF method of valuation, which is based on the notion that a corporation’s value equals the present value of its future cash flows.”

The Court observed that the largest disagreement between the parties over aspects of the DCF value was over the discount rate to use.  Each expert used three different methods to arrive at the discount rate.  Two of the methods are versions of the so called “build-up” model, which is a method that is filled with subjectivity, and uses elements “not accepted by the mainstream of corporate finance scholars.”  Instead, the third method each of the experts used to determine the discount rate was based on the Capital Asset Pricing Model (“CAPM”) that is the widely accepted model for valuing corporations.  That is the only method that the Court used.

After applying the recognized supply-side equity risk premium, which is recognized in prior Delaware appraisal opinions, the parties and Orchard agreed that the discount rate under the CAPM method is 15.3%.

As a historical matter, prior to the merger, after a Special Committee was formed and a formal valuation was done by Fesnak and Associates, and after the Special Committee and the full board approved the merger at an annual meeting, the majority of the minority stockholders voted in favor of the merger.

Although there was some discussion about the efforts of the majority shareholder to sell the company, before it decided to buy out the minority, the Court emphasized that this was a statutory appraisal action and the focus was on the value of Orchard as a going concern, and not on the quality of the efforts to market the company.  Thus, the testimony at trial focused mostly on the value of Orchard as a going concern as of the date of the merger, based on Cavalier Oil and its progeny.

Legal Analysis

Pursuant to DGCL Section 262, the Court explained the well-known standard in a statutory appraisal action which requires the Court to “determine the fair value of the shares exclusive of any element of value arising from the accomplishment or expectation of the merger for consolidation, together with interest, if any, to be paid upon the amount determined to be the fair value.” 

For purposes of an appraisal proceeding, the Court explained that “fair value” means the “value of the company to the stockholder as a going concern, rather than its value to a third party as an acquisition.”  Moreover, the Court considers:  “All relevant factors known or ascertainable as of the merger date that illuminate the future prospects of the company, but any synergies or other value expected from the merger giving rise to the appraisal proceedings itself must be disregarded.”  See footnotes 20 to 22.

Each party bears the burden to prove their respective valuations and the Court has discretion to select one of the valuation models or to create its own, but it must use its own independent judgment.  See footnotes 24 and 25.

The biggest difference in the approaches of the experts was regarding how to value the preferred stock.  The expert of the petitioner was from Willamette Management Associates.  The company’s expert was from Fesnak and Associates, who was also the financial advisor to the Special Committee. 

In rejecting the approach of the expert for the company regarding the valuation of the preferred shares, the Court described the position of the company’s expert as follows:  “Ever-evolving yet constantly confused arguments . . .”  The Court also described the argument in the company’s briefs regarding valuation as follows:  “. . . illogical, and non-factual . . .”  In rejecting the argument that was contrary to the clear terms of the Certificate of Designation that the valuation should take into consideration the future liquidation preference even if it was not triggered by the merger, the Court relied on a prior Delaware decision that rejected a similar argument.  See In Re:  Appraisal of Metro Media International Group, Inc., 971 A.2d 893 (Del. Ch. 2009).

The Court acknowledged that regardless of what market realities may exist, an appraisal remedy is designed to address the potential for a majority shareholder to treat the minority unfavorably.  Although Delaware law gives the majority shareholders the right to a control premium, the law limits the chance of getting one by requiring minority stockholders to be treated on a pro rata basis in an appraisal proceeding.  See footnote 45 (citing Cavalier Oil Corp., and noting that this approach takes into account the “risky, time-consuming and burdensome remedy that involves a stockholder tying up its investment in a legal proceeding for several years and having to bear its own costs of prosecution, without any guarantee to receive any floor percentage of the merger consideration.”)

Although the Court relied on the DCF analysis, it referred to the use of a comparable company method as “rooted in the same intuition as the DCF method.”  The Court explained that comparable company method allows comparisons to similar companies and the drawing of inferences about the future expected cash flows from the expectations of the market about those comparable companies.  See footnotes 54 to 57 (which include citations to two seminal works in the field by Shannon P. Pratt, including his well known reference: The Lawyer’s Business Valuation Handbook).  In this case, however, because the company was in a niche market, it was difficult to find companies that actually do the same thing, thereby making the comparables approach less reliable.

The Court explained the basic premise underlying the DCF methodology and its component parts.  See Slip op. at 29.

In choosing one method that is widely recognized for determining the discount rate, instead of blending several different methods, the Court reasoned as follows:

“As a law-trained judge who has to come up with a valuation, deploying the learning of the field of corporate finance, I choose to deploy one accepted method, as well as I am able, given the record before me and my own abilities.” 

See Slip op. at 42.

Conclusion

After a thorough explanation of the reasoning that led to the conclusion of the Court in this 55-page decision, (including mathematical “equations with letters” more likely to be found in a finance textbook, and that I do not include in this overview), the Court gave the parties the opportunity to explain if any adjustments the Court made that were different than either of the expert reports, needed editing, because “the parties failed to engage on several issues” until after post-trial oral argument.

Postscript: Kevin Brady’s videocast for LexisNexis provides a short overview of the case.

Supplement: We recently posted an overview of Delaware law on fair value in appraisal cases based on DGCL Section 262, available here.

Grunstein v. Silva, C.A. No. 3932-VCN (Del. Ch. July 2, 2012).

Issue Addressed: Whether opposing counsel must certify their agreement to restricted access before viewing documents entitled to a Highly Confidential designation.

Short Answer: The Court required a certification to be signed by attorneys at Dechert LLP before they would be given access to produced documents.

Background:

The extensive background facts in this long-running dispute are described in the multiple prior Delaware decisions in this case that have been highlighted on these pages and are available here.

In reply to discovery requests Defendants were given pleadings and court filings from an action pending in Maryland, as well as Discovery Documents which had been produced in the Maryland case, and placed a “Highly Confidential” designation on all the Maryland Documents (the Discovery Documents along with the Court Documents). Because of the designation, only four lawyers at Dechert LLP (a law firm representing the Defendants) were allowed to look at the documents.

Defendants sought to vacate the Highly Confidential designation.

Defendants asked to allow additional attorneys to review the documents, however Plaintiff refused unless those attorneys certify that “…neither …[they] nor any of their current or former clients are involved in healthcare or financing and that they won’t represent clients in those areas [during the pendency of this case].”

Analysis:

The Court Documents which were created for the Maryland action were designated as Highly Confidential pursuant to an order entered by the Circuit Court of Maryland. The Court of Chancery found the circumstances not compelling enough to de-designate an order from another court of another state, although it was not bound by the other court’s ruling. While the Defendants primarily wanted access to an affidavit, the Defendants could have received the same facts through a deposition.

The Court ordered the producing party to review all of the Discovery Documents and determine in good faith whether they deserve a Highly Confidential designation. The Defendants may also request a de-designation of any documents they believe relevant and not entitled to the Highly Confidential treatment.

The Court held that the Dechert attorneys may review the Maryland Documents if they certify that during the pendency of this case they will neither be involved in the related New York Litigation nor represent any client in a matter involving the purchase or sale (including financing) of any nursing home or adult assisted-living center.

WaveDivision Holdings LLC v. Highland Capital Management, L.P., et al., No. 649,2011 (Del. Supr., July 19, 2012). 

Issue Presented:

Whether the Superior Court properly granted summary judgment in favor of defendant note holders and senior lenders on the issue of whether defendants tortiously interfered with plaintiff WaveDivision Holdings’ contract with third-party Millennium Digital Media Systems, LLC (“Millennium”) to purchase cable television systems from Millennium.

Short Answer:  Yes.  Appeal affirmed.

Brief Overview:

Millennium obtained financing by selling $70 million of unsecured high-yield senior increasing rate notes (the “IRNs”).  Millennium also had first-tier senior secured creditors (the “Senior Lenders”), which gave the Senior Lenders a first priority lien on substantially all of Millennium’s assets.  Like the IRN Agreement, this credit agreement gave the Senior Lenders disclosure  and consent rights.  When Millennium faced financial problems, it sought covenant relief from the Senior Lenders in order to avoid defaults.  The parties executed an agreement which required Millennium to sell all or substantially all of its assets to repay the Senior Lenders.  In connection with that sale, Wave submitted an offer to purchase the Michigan and Northwest cable systems from Millennium for $157 million.  Despite the IRN Holders believing that the price was inadequate, Millennium and Wave entered into an Asset Purchase Agreement (the “APA”) for the Michigan system and a Unit Purchase Agreement (the “UPA”) for the Northwest System.  Both agreements required the consent of the IRN Holders and the Senior Lenders, unless Wave and Millennium reasonably believed that such consent was not necessary.  Around this time, Highland Capital purchased additional senior debt in order to protect its stake in Millennium.  At the same time, Highland Financial Corporation submitted a refinancing proposal to Millennium which called for a full debt-for-equity swap of the IRNs and was contingent on the termination of the agreements.

Wave subsequently informed Millennium that it had reviewed the IRN Agreement and had concluded that the IRN Holders’ consent to the APA and UPA was not required.  Highland Capital, however, sent a letter to Wave on behalf of seven Senior Lenders, informing Millennium that those Senior Lenders did not consent to the APA and UPA.  Millennium then notified Wave of its decision to terminate the agreements and at the same time, Millennium accepted the refinancing proposal from Highland Capital, Trimaran and the other IRN Holders, pursuant to which the IRN Holders’ interests were converted into equity interests.

Wave filed suit in the Superior Court against certain creditors of Millennium seeking damages for tortious interference with the Wave-Millennium contract.  The Superior Court granted summary judgment to defendants on this claim, concluding that any interference was justified under Delaware law.  Note, there is a companion decision from the Court of Chancery dated Sept. 17, 2010 awarding damages for breach of the “no solicitation” and “reasonable best efforts” clauses of the APA, which is available here.

Analysis

On appeal, Wave argued that the Superior Court erred in determining that any interference was justified and that the Superior Court ignored evidence in the record of improper conduct, which raised at least a triable issue of fact on the tortious interference claim.  Wave argued that courts must evaluate any improper motive together with any proper motive, to determine which motive predominates for assessing a tortious interference claim.  Because Delaware courts follow Section 766 of the Restatement (Second) of Torts, Wave had to show that : “(1) there was a contract, (2) about which the particular defendant knew, (3) an intentional act that was a significant factor in causing the breach of contract, (4) the act was without justification, and (5) it caused injury.” Section 767 of the Restatement contains a number of factors to consider in determining if intentional interference with another’s contract is improper or without justification, such as: (i) the nature of the actor’s conduct; (ii) the actor’s motive; (iii) the interests sought to be advanced by the actor; and (iv) the relations between the parties.

In rejecting Wave’s argument, the Court stated that “[t]he defense of justification does not require that the defendant’s proper motive be its sole or even its predominate motive for interfering with the contract.  Only if the defendant’s sole motive was to interfere with the contract will this factor support a finding of improper interference.”  The Superior Court had recognized that the IRN Holders and Senior Lenders were motivated at least in part by a desire to protect their investment in Millennium, and not solely by a desire to interfere with a Wave-Millennium deal. Thus, the Supreme Court found that the Superior Court properly concluded that the motive factor weighed in favor of justification.

Wave also argued that the defendants used improper means to interfere with the Wave-Millennium deal by making false representations and that they used inside information and exerted economic pressure.  Under Delaware law, “[a] representation is fraudulent when, to the knowledge or belief of its utterer, it is false in the sense in which it is intended to be understood by its recipient.”  Here, however, the Court found that Wave produced no evidence that Highland Capital made any such representations.  Moreover, the Court found that Wave’s arguments regarding the use of inside information and economic pressure also lack adequate support in the record.  Finally, the Supreme Court stated that:

[t]he Superior Court concluded that four of the seven Restatement factors — the nature of the actor’s conduct; the actor’s motive; the interests sought to be advanced by the actor; and the relations between the parties — weighed against a finding of improper interference. We find no error in the Superior Court’s analysis….

Professor Stephen Bainbridge, frequently cited by the Delaware courts for his corporate scholarship, and a friend of this blog, recently published an article on the doctrine based on the Delaware Supreme Court decision in Revlon that addresses the duties of directors when a corporation is “for sale” and related nuances. The good professor’s article, now available on SSRN, is entitled: The Geography of Revlon-Land. [UPDATE: An updated version was announced on Professor B’s blog here.]

The abstract follows:

In Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986), the Delaware Supreme Court explained 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.”

Unfortunately, the Court’s colorful metaphor obfuscated some serious doctrinal problems. What standards of judicial review applied to director conduct outside the borders of Revlon-land? What standard applied to director conduct falling inside Revlon-land’s borders? And when did one enter that mysterious country?

By the mid-1990s, the Delaware Supreme Court had worked out a credible set of answers to those questions. The seemingly settled rules made doctrinal sense and were sound from a policy perspective. 

Indeed, my thesis herein is that Revlon and its progeny should be praised for having grappled — mostly successfully — with the core problem of corporation law: the tension between authority and accountability. A fully specified account of corporate law must incorporate both values. On the one hand, corporate law must implement the value of authority in developing a set of rules and procedures providing efficient decision making. U.S. corporate law does so by adopting a system of director primacy.

In the director primacy (a.k.a. board-centric) form of corporate governance, control is vested not in the hands of the firm’s so-called owners, the shareholders, who exercise virtually no control over either day-to-day operations or long-term policy, but in the hands of the board of directors and their subordinate professional managers. On the other hand, the separation of ownership and control in modern public corporations obviously implicates important accountability concerns, which corporate law must also address.

Academic critics of Delaware’s jurisprudence typically err because they are preoccupied with accountability at the expense of authority. 

In contrast, or so I will argue, Delaware’s takeover jurisprudence correctly recognizes that both authority and accountability have value.

Achieving the proper mix between these competing values is a daunting — but necessary — task. Ultimately, authority and accountability cannot be reconciled. 

At some point, greater accountability necessarily makes the decision-making process less efficient. Making corporate law therefore requires a careful balancing of these competing values. Striking such a balance is the peculiar genius of Unocal and its progeny.

In recent years, however, the Delaware Chancery Court has gotten lost in Revlon-land. A number of Chancery decisions have drifted away from the doctrinal parameters laid down by the Supreme Court. In this article, I argue that they have done so because the Chancellors have misidentified the policy basis on which Revlon rests. Accordingly, I argue that Chancery should adopt a conflict of interest-based approach to invoking Revlon, which focuses on where control of the resulting corporate entity rests when the transaction is complete.

Picard v. Wood, C.A. No. 6526-VCG (Del. Ch. July 12, 2012).

Issue Presented

Whether a member of a limited partnership is subject to personal jurisdiction in Delaware based on that status alone.

Short Answer: No.

Brief Overview

This short letter ruling granted a motion to dismiss for lack of personal jurisdiction, for claims against the member of a Delaware limited partnership who allegedly was the recipient of funds, as a limited partner, of a so-called “feeder fund” that allegedly played a role in the epic ponzi scheme of Bernard Madoff.

Analysis
The Court emphasized the well-settled Delaware law that:  “Mere membership in a Delaware limited partnership, absent additional considerations, is insufficient to confer personal jurisdiction.”  See footnote 5 and cases cited therein.  The Court explained that the plaintiffs did not allege or provide evidence that the defendant either managed or controlled or exerted influence over the limited partnership, and therefore, there was no jurisdiction on the basis of his membership alone in the Delaware limited partnership.

The Court conducted the usual analysis in connection with a motion to dismiss for lack of personal jurisdiction, including the two-part inquiry:  (1) Whether jurisdiction is proper under one or more provisions of the Delaware long arm statute, see 10 Del. C. Section 3104(c)(1); and also (2) Whether the exercise of jurisdiction would comport with the requirements of constitutional due process.

In sum, there were insufficient allegations to meet the first prong of the inquiry, and therefore, there was no need to address the second prong.