Prof. Lucian Bebchuk of the Harvard Law School authored a study that analyzes the stock market reactions to both the Delaware Chancery Court ruling in Airgas that, he argues, weakened the anti-takeover force of staggered boards, and the Delaware Supreme Court Airgas ruling that overturned it.

He provides the following overview to the analysis:

We find that the first ruling benefitted shareholders of affected companies and that the second ruling eliminated these gains. Our consistent findings over the two events enable us to confirm with high level of confidence that market participants place a positive value on weakening the anti-takeover force of staggered boards and that shareholders would do well to continue pressing for board declassification and that the ongoing process of board declassification is likely to benefit shareholders. 

The study is available here. Prof. Larry Ribstein comments on the study and its analysis here.

 

Reis v. Hazelett Strip-Casting Corp., C.A. No. 3552-VCL (Del. Ch. Jan. 21, 2011), is a recent opinion, available here, of the Delaware Court of Chancery that is critiqued here by Professor Stephen Bainbridge, one of the nation’s leading corporate law scholars who is cited often in Delaware court opinions. He discusses this and many other Delaware decisions that address the business judgment rule and he explains his reasons for asserting why the BJR is not a standard of review but rather should be viewed as an abstention doctrine.

The good professor will be sharing his wisdom at a corporate law seminar scheduled for May 12, 2011 in Wilmington, Delaware, and he suggests in the post at the above link that this topic could be part of his presentation. Prof. Bainbridge also solicits topics for his Delaware appearance in a post here.

KFC National Council and Advertising Cooperative, Inc. v. KFC Corp., C.A. No 5191- VCS (Del. Ch. Jan. 31, 2011), read 65-page opinion here. The Court of Chancery agreed with the arguments of the franchisees in their interpretation of a corporate charter that impacted a dispute over who controlled advertising and marketing strategy for the 5,000 restaurant KFC chain. More details about this important decision will come later.

ABC News reported on the case here.

Supplemental Overview

Issue Addressed:

This case involved a dispute between parties over who has authority to determine national advertising strategy for the KFC brand, based on the organizational documents of the entity involved.

Overview:

Plaintiff “NCAC” is a non-stock corporation that is authorized to serve as the “advertising arm” for the KFC brand in the U.S. The NCAC Committee serves as the NCAC’s governing body. The franchisees have a majority control of the NCAC Committee.

The resolution of this case revolves around an interpretation of the NCAC’s Certificate of Incorporation. The key question was the extent to which the NCAC Certificate constitutes a contract in which NCAC agreed to give veto power to KFCC on advertising matters.

As with any contract case, the Court provided extensive background details about the basic dispute giving rise to the case and then a consideration of the relevant contractual test.

Based on the theory that readers of this blog do not want a case summary that competes with the 65-page length of this opinion, I will use the time-honored approach of using bullet points for selected key legal parts of the opinion.

Key Legal Principles Addressed:

● The Court applied common principles of contract interpretation to address the dispute regarding the meaning of the Certificate of NCAC; and due to ambiguity in its terms, the Court looked to decades of extrinsic evidence, including course of performance. FNs 45 to 50.

● However, parol evidence is typically not helpful in governing instruments such as a certificate that are not the produce of bilateral negotiation. FNs 53 and 54.

● Moreover, when the rights of equity holders are curtailed, those restrictions must be clear, and any ambiguity will be construed against the diminishment of power that would otherwise be vested in a majority of stockholders or board members. FNs 55 to 57.

● Chancery did not limit its analysis only to the text of the certificate, but also relied on the public policy “default position” supporting majority rule by the corporate board (in this case the NCAC Committee).

● But the extrinsic evidence also supports the franchisees’ interpretation of the Certificate and how its power interfaces with the role of KFCC in the parties’ relationship.

King v.VeriFone Holdings, Inc., Del. Supr., No. 330, 2010 (Jan. 28, 2011), read opinion here, is a Delaware Supreme Court decision that provides added clarity to practitioners regarding the "proper purpose" and related prerequisites that a shareholder must satisfy in order to successfully seek books and records under DGCL Section 220. This ruling reversed a Chancery decision that found a lack of proper purpose in part because the Section 220 action was filed after a derivative suit was filed. Delaware’s High Court explained that it remains preferable to file Section 220 suits to obtain books and records prior to filing a derivative suit, but following that chronology is not, per se, a fatal flaw in a Section 220 action. I plan to provide a fuller summary on this case later.

This decision also highlights how contentious, lacking in simplicity and expensive Section 220 cases can be. I say lacking in simplicity because it is rare for the members of the Delaware Supreme Court and Court of Chancery to disagree on the interpretation of the DGCL. Also, I say expensive because appeals to the Delaware Supreme Court don’t come cheap. And remember that after all that effort, what does one win in a Section 220 case? Books and records only.

Supplement

Background details about this case are available in the blog summary of the Chancery decision here. In sum, a shareholder derivative complaint was filed in California based on the defendant’s restatement of financial statements.

Notably, VeriFone provided most of the requested “categories of documents” that were sought before suit except one:  “The Audit Committee Report with the results of an internal investigation regarding the issues surrounding the restatement of VeriFone’s financial statements.”  This demand for books and records was pursuant to the specific direction of the federal court in which the derivative suit was pending, to use DGCL § 220 to amend the complaint in that case, in order to assist King in pleading demand futility in the California suit.

Supreme Court’s Section 220 Analysis

Delaware’s High Court recognized “investigation of corporate mismanagement” as a “proper purpose” for seeking books and records pursuant to DGCL § 220, among others.  Other cases were cited for the Delaware Court’s frequent exhortations to practitioners to use DGCL § 220 to obtain detailed information prior to a plenary lawsuit, in order to obtain the detailed facts needed to successfully plead “demand futility” for purposes of satisfying Court of Chancery Rule 23.1 in derivative suits.

Delaware’s High Court recognized that it may be ill-advised to file a § 220 suit after a derivative case is filed, but the Court explained that such a sequence “has not heretofore been regarded as fatal.”

Three Delaware decisions were discussed at length to support the Court’s reasoning that: “both this Court and the Court of Chancery [have] permitted stockholder-plaintiffs to utilize the Section 220 inspection process to gather new information and replead their derivative complaints.”  See slip op. at 11 and footnotes 25, 33 and 40 (citing Disney, McKesson HBOC and Melzer cases).  Two other Delaware cases that reached a different result were distinguished.  See slip op. at 17 and footnotes 48 and 56.

The Court emphasized that it was reaffirming “long-standing Delaware precedent” recognizing that a proper purpose under Section 220 includes seeking books and records to aid in pleading demand futility in a “to-be-amended” complaint in an existing plenary derivative action.

Moreover, while rejecting the trial Court’s holding that a prerequisite of a § 220 action is to file a § 220 suit prior to a derivative suit; the Delaware Supreme Court did not endorse that particular sequence as a best practice in connection with filing a § 220 suit.

Conclusion

Although the Court was sensitive to the policy issues involved with its rejection of a bright-line test for the timing of a § 220 suit, it explained that the Delaware General Assembly would need to amend the statute to impose a sequential prerequisite, and it would not be appropriate for the judiciary to do so.

 

 

On January 24, 2011, the Court of Chancery in Air Products & Chemicals, Inc. v. Airgas, Inc., et al. C. A. No. 5249-CC,  issued a written decision explaining its January 21, 2011 oral ruling denying Airgas’s motion to exclude the testimony of Air Products’ expert witness, Joseph J. Morrow, at the supplemental evidentiary hearing. Read letter ruling here.

This summary was prepared by Kevin F. Brady of Connolly Bove Lodge & Hutz LLP.

By way of background, after trial in October 2010, Air Products raised its offer from $65.50 to $70 per share. The Court then scheduled a supplemental evidentiary hearing regarding Air Products’ position that $70 per share was its “best and final” offer and the Airgas board’s decision to reject that offer as “clearly inadequate.” On January 5, 2011: Airgas (i) identified an expert witness, Peter C. Harkins, who had testified at trial as to the realistic attainability of a 67% vote at a special meeting to remove and replace Airgas’s sitting directors; and (ii) produced Harkins’ Second Supplemental Expert Report which addressed several issues, but did not offer an opinion regarding the “67% vote” issue. On January 12, Air Products advised that it did not intend to call a rebuttal witness to address the testimony of Harkins, but reserved the right to do so if Harkins testified on matters outside the scope of his Second Supplemental Expert Report. When Harkins was deposed on January 14, 2011, counsel for Air Products questioned him on his views about the “67% vote” issue and Airgas did not object. On January 18, 2011, Air Products’ advised that it now intended to call Joseph J. Morrow as an “expert rebuttal witness, ”and that it would “promptly produce” Morrow’s expert report which it did on January 20, 2011 (one day before the discovery cut-off). Morrow’s expert report addressed matters beyond those addressed in Harkins’s second supplemental report, including the “67% vote” issue. Airgas then moved to exclude the testimony of Morrow.

Airgas argued that it did not have adequate time to fully prepare for Morrow’s deposition and therefore Morrow’s testimony and report should be excluded. In the alternative, Airgas asked the Court to preclude Morrow from testifying with respect to the “67% vote” issue. Airgas also argued that since Harkins did not opine on this issue in his Second Supplemental Report, it was not a proper subject for a “rebuttal.” Finally, Airgas argued that in the event that Morrow was allowed to testify that Harkins be permitted to testify on the “67% vote” issue. Air Products argued that (i) the “67% vote” topic was addressed at Harkins’s deposition, (ii) Airgas questioned Air Products’ witnesses on this subject, and (iii) Airgas failed to demonstrate any prejudice. Air Products also argued in the alternative that it would agree to a limitation preventing either party from offering testimony on the “67% vote” issue.

The Court found that the expert report was timely produced and as a result, Morrow was not precluded from testifying. The Court also noted that while the “67% vote” was not addressed in Harkins’s second supplemental report, Harkins had opined on this issue before and was questioned about it in his deposition by Air Products’ counsel. The Court concluded that Airgas would not be prejudiced by the admission of Morrow’s report and testimony, and that Air Products would be entitled to rebut the testimony given by Harkins. The Court also granted Airgas’s request that Harkins be permitted to testify in response to Morrow’s testimony on the “67% vote” issue.

 

U.S. v. Florida, (N.D. Fl., Jan. 31, 2011), read opinion here. Though this decision may appear far afield from the usual business litigation fare of this blog, because this federal decision declaring unconstitutional the federal health care law passed last year is of such far-reaching impact on businesses (and individuals), and because it has some broadly applicable constitutional analysis of the Commerce Clause of the U.S. Constitution, I make it available at the above link for the convenience of readers. I also quote below from an introductory part of the opinion, taken from a fundamental text that is often used to explain the genesis and intent of our system of government in the U.S. The quote is also applicable to human dynamics in general.

James Madison, the chief architect of our federalist system, once famously observed:

If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary. In framing a government which is to be administered by men over men, the great difficulty lies in this: you must first enable the government  to control the governed; and in the next place oblige it  to control itself.

The Federalist  No. 51, at 348 (N.Y. Heritage Press ed., 1945).

Professor Larry Ribstein has added to his extensive scholarship on jurisdictional competition, in which Delaware’s role is prominently featured, with an article linked as part of his descriptive post here. The abstract follows:

Most of the work on jurisdictional competition for business associations has focused on publicly held corporations and the factors that have led to Delaware’s dominant position in attracting out of state firms. Is there an analogous jurisdictional competition to attract formations by closely held firms? Limited liability companies (LLCs) offer a good opportunity to examine this question. Most LLC statutes have been adopted and changed rapidly during the past 20 years. Unlike general and limited partnerships, which have been shaped by uniform laws, LLC statutes vary significantly, and states have devoted a lot of effort to drafting their individual statues. This variation provides an opportunity to test the statutory provisions and other factors that influence LLC’s choice of where to organize. We find little evidence that firms choose to form outside their home state in order to take advantage of variations in statutory provisions. Instead, we find evidence that large LLCs, like large corporations, tend to form in Delaware, and that they do so for the many of the same reasons – that is, for the quality of Delaware’s legal system.

 

Depositions in Delaware are subject to rules of practice and procedure that are materially different in form and substance to what I have observed in many other states. Both the Delaware Chancery Court and the Delaware Supreme Court enforce the rules relating to deposition practice and take it very seriously.

In a seminar last week, Delaware lawyers C. Malcolm Cochran, IV and Norman Monhait joined with Vice Chancellor John Noble of the Chancery Court, on a panel that described the highlights of the “Delaware way” of taking and defending depositions.

They graciously agreed to share their materials with us which I linked when this post was originally written in 2011. Mike Cochran kindly allowed me to link here to an updated version of materials he prepared in 2015. Those materials address the parameters of proper conduct, especially by lawyers, in a deposition.

See generally, Delaware Supreme Court 2019 decision that addresses errant behavior by the deponent, that I highlighted on these pages.

The attached updated materials include cases and rules that any lawyer taking depositions in a Delaware proceeding should be familiar with if they want to avoid the wrath of the court and if they do not want their wallet lightened from the costs they might need to pay for not following the proper procedures and practices in this important aspect of Delaware litigation. The panel supplemented the materials linked above with a Chancery Court case that penalized an attorney by making him pay for the opposing side’s attorneys’ fees for a deposition in which the defending attorney improperly interrupted and interfered with the deponent’s answers. The Court emphasized that it “will not tolerate a lawyer supplanting a witness in a deposition”. In Re Fuqua Industries, Inc. Shareholder Litigation, 752 A.2d 126, 135-36 (Del. Ch. 1999).

UPDATE: A 2014 decision by Special Master Boyer in the Mine Safety case is a useful resource for citations to Delaware authority for reference in addressing issues of proper deposition practice in Delaware.

Lavi v. Wideawake Deathrow Entertainment LLC, C.A. No. 5779-VCS (Del. Ch. Jan. 18, 2011), read letter ruling here.

Issue Addressed

The issue decided by the Court of Chancery in this books and records action under Section 18-305 of the Delaware Limited Liability Company Act was whether a motion to dismiss the complaint should be granted in light of the multiple documents that were attached to the motion that went beyond what the Court could properly consider at the early stages of the summary proceeding. Thanks to counsel for the plaintiff, David L. Finger, a Delaware litigator, for forwarding this letter ruling to us.

Brief Overview of Decision

This short 3-page letter ruling can be most efficiently summarized in classic bullet point fashion as follows:

1) The Court emphasizes in several parts of the ruling that books and records actions in Delaware are summary proceedings that should receive prompt trial dates.

2) The author of the letter ruling in this case does not favor dispositive motions in books and records cases, in light of their nature as summary proceedings, “when a trial can take place within two months of filing” a complaint, (although, in the past, other members of the Court have granted dispositive motions in books and records cases).

3) The Court provides pointed instruction on motion practice to the extent that a motion to dismiss under Rule 12(b)(6) is contrasted with a motion for summary judgment. Specifically, the Court explained that when documents beyond those contained or referenced in the pleadings are attached to a motion to dismiss, it is converted into a motion for summary judgment.

4) The Court explained that it could not properly consider all the documents attached to the motion of the defendant through either judicial notice or otherwise. Instead, the Court denied the motion and ordered the parties to submit a proposed schedule for a prompt trial “as is contemplated in books and records actions.”

Great-West Investors LP v. Thomas H. Lee Partners, L.P., C.A. No. 5508-VCN (Del. Ch. Jan. 14, 2011), read opinion here.

Issue Addressed

This 37-page decision from the Delaware Court of Chancery addresses multiple contract interpretation issues between two sophisticated parties. The most memorable issue addressed in the decision – – and one that’s less commonly known among business litigators, is that “an agreement to negotiate in good faith could be an enforceable contract term subject to specific performance.” See page 24 and footnote 61.

Brief Overview

The opinion starts with the first full page explaining an old Chinese folktale that involved a mathematical exercise that explained the hugh numerical sums that were arrived at when a simple amount is doubled and that amount is doubled again and then that amount is doubled yet again in successive instances.

One of the parties to the agreement involved was seeking relief from the onerous contract formula for fees that were paid under the agreement in connection with private equity funds. This opinion addresses the contract theories that one might consider in an effort to obtain judicial assistance in escaping an otherwise unhappy bargain. The bottom line is that the Court emphasized that it will not provide reformation of “bad bargains” especially when the agreement is between sophisticated parties. To some extent the plaintiff realized this when it referenced in passing but did not seriously assert the theory of unconscionability. See footnotes 48 and 49. Because the moving party realized that it could not rely on the theory of unconscionability, claims were made based on more conventional breach of contract theories, as well as an alleged breach of the implied covenant of good faith and fair dealing, and also the alleged breach of fiduciary duty.

Procedural Posture

Ruling on a motion to dismiss, the Court determined that the parties’ obligations and rights were expressly governed by contract and therefore the doctrine of the implied covenant of good faith and fair dealing did not apply. However, the court found that there was a basis to allow the claim for reformation based on fraud to proceed, if only barely.

Procedural Standard on Motion to Dismiss

The Court explained the standard under Rule 12(b)(6) for a motion to dismiss that is used by the Court, as follows: The motion would only be granted if “the plaintiff would be unable to recover under any reasonably conceivable set of circumstances susceptible of proof.” See footnotes 33 and 34 (citing DeSimone v. Barrows, 924 A.2d 908, 928 (Del. Ch. 2007)). 

Compare: recent Chancery opinion citing to U.S. Supreme Court decision in Twombly for a slightly different standard applicable to Rule 12(b)(6) motions, as discussed in post here.

Discussion

The Court explained that “an agreement to negotiate in good faith may be binding under Delaware law,” and specific performance could, in theory, be an appropriate remedy for breach of such a provision. In practice, however, “the problems with ordering parties to negotiate in good faith are significant.” See footnotes 61 and 62. The Court explained that “although it might be difficult to win an order enforcing other aspects of the duty to negotiate in good faith, the Court is not now prepared to state that there are no circumstances under which specific performance would be an appropriate remedy for Great-West if it can prove a breach . . ..”

The Court relied on the recent Delaware Supreme Court decision in Nemec v. Schrader to dismiss an alleged breach of fiduciary duty. Relying on Nemec, the Court explained that “where a dispute arises from obligations that are expressly addressed by contract, that dispute will be treated as a breach of contract claim. In that specific context, any fiduciary claims arising out of the same facts that underly the contract obligations would be foreclosed as superfluous.” See footnote 65.

Lastly, before it addressed the claims for reformation based on mistake or fraud, the Court explained that there are three possible justifications for reforming an agreement: mutual mistake, unilateral mistake and fraud. The Court allowed the reformation claims based on all three arguments to proceed.

SUPPLEMENT:  Professor Stephen Bainbridge links to this post on his blog here and provides commentary on this case, with reference to one of the many books on corporate law that he has authored.