On November 3, 2010, in Airgas, Inc. v. Air Products and Chemicals Inc., No. 649,2010, the Delaware Supreme Court held oral argument in the expedited appeal by Airgas of the Court of Chancery’s October 8, 2010 decision. (A summary of that Chancery decision, as well as posts on prior Chancery decisions in this case, and commentary by leadings academics, are available here.) The Supreme Court went en banc for this hearing with the exception of Justice Jack B. Jacobs who did not participate in the hearing; Superior Court Judge William L. Witham Jr. sat by designation. 

Ted Mirvis of Wachtell Lipton Rosen & Katz argued for Airgas. Gary Bornstein of Cravath Swaine & Moore LLP argued for Air Products. The three appellate briefs of the parties can be downloaded in the sequence they were filed, as follows: Opening; Answering and Reply. The audio recording of the oral argument  before the Supreme Court can be accessed here. 

This report was submitted by Kevin F. Brady of Connolly Bove Lodge & Hutz LLP

 

There were three issues raised by Airgas on appeal. Airgas argued that the Court of Chancery erred in its decision that: (i) DGCL § 141(d) does not provide that the term of three-class directors on a Delaware staggered board is three years; (ii) the Bylaw was consistent with the staggered board provision in Airgas’ charter; and (iii) the enactment of the Bylaw did not require a supermajority vote of the stockholders. 

 

In arguing for reversal, Airgas stated that this is a case about staggered boards and the statutory construction and policy behind DGCL §§ 141(d) and 211. It also argued that the bylaw amendment proposed by Air Products significantly undercut the permitted use of a staggered board. Moreover, the bylaw amendment cannot be reconciled with DGCL § 211’s requirement that Delaware corporations hold “annual” meetings when there would be two shareholder meetings within four months of each other, with no apparent business purpose for the second meeting other than to replace one third of the board of directors. From a practical point of view, because the Airgas fiscal year runs until March 31, if the bylaw is allowed to stand, it would allow Airgas to hold two annual shareholder meetings in the same fiscal year. 

 

Airgas relied on the 1960 Court of Chancery case Essential Enterprises Corp. v. Automatic Steel Prods., 159 A.2d 288 (Del. Ch. 1960), where Chancellor Seitz held that under § 141(d) directors on three-class staggered boards serve three-year terms. The Court found that “the statute says that ‘directors shall be chosen for a full term’ and ‘[c]learly the ‘full term’ visualized by the statute is a period of three years.’” Airgas also argued that the legislative history of § 141(d), together with the statements of numerous courts, practitioners, academics and the American Bar Association model form and commentary for Delaware corporations, further reinforced the common understanding that directors on staggered boards serve three year terms. 

Air Products told the Court that the issue should be framed differently because this is not a case about classified boards; it is a case about annual meetings. Instead of looking to DGCL § 141(d) for guidance, Air Products argued that Airgas should be looking at DGCL § 211 governing the timing of annual meetings. That section states that the date of an annual meeting shall be "designated by or in the manner provided in the bylaws". Pursuant to that section, Delaware corporations and their stockholders have wide latitude to set their annual meeting schedule, subject only to the specifically enumerated constraints appearing in § 211(c). In particular, an annual meeting must be held prior to the expiration of "13 months after the latest to occur of the organization of the corporation, its last annual meeting or the last action by written consent to elect directors in lieu of an annual meeting". Moreover, there are maximum time periods but no minimum time periods and "annual" does not mean "separated by twelve months."

The Supreme Court took the matter under advisement. Because this is an expedited appeal, it is anticipated that a decision could be issued by November 15. 

 

An article on "cloud computing" and the related legal and ethical issues that lawyers should be aware of, was published by Kevin F. Brady of the Connolly Bove firm, regarding this increasingly important topic. The article is featured in the current issue of The Bencher, the national publication of The American Inns of Court, and is available here.

The current issue of Delaware Lawyer magazine includes an article I co-authored with my partner, Jeff Schlerf, on the duties of directors and managers of distressed companies, for example, those faced with the decision of whether to file for bankruptcy or attempt other methods to "save the company". I review recent Delaware Court of Chancery and Supreme Court cases, and Jeff approaches the topic through a discussion of recent bankruptcy decisions. The article is available here.

SUPPLEMENT: Professor Bainbridge links to this post here, and also refers to his own scholarship on the topic.

For my regular ethics column in the current issue of The Bencher, the national publication of The American Inns of Court, available here, I write about conflicts of interest involving related entities. The topic of the article, as follows, fairly describes the scope of the short column:  "Second Circuit Disqualifies Law Firm for Representation Adverse to Client’s Subsidiary".

 I wrote a feature article for the current issue of The Bencher, a publication of The American Inns of Court, that describes the cutting edge issues involved with electronic discovery of data on social networking sites that may have relevance to issues in a pending lawsuit. The short piece is available here.

We have been named to the LexisNexis Top 25 Blogs for 2010 for its Corporate & Securities Law Community and UCC, Commercial Contracts and Business Law Community.

LexisNexis Top 25 Blogs 2010

Kevin F. Brady and I are quite proud to be among such blog honorees as The Conference Board’s Corporate Governance Blog, the Harvard Law School Forum on Corporate Governance,  The Conglomerate, and The D & O Diary, among others. The complete list is available here.

Postscript: The Wall Street Journal’s online edition linked to this post here.

The Court of Chancery denied a motion to expedite an application to preliminarily enjoin the merger of the limited partnership in Lonergan v. EPE Holdings LLC, C.A. No. 5856-VCL (Del. Ch. Oct. 11, 2010), read opinion here, where the plaintiff failed to plead colorable claims of breach of fiduciary duty and the Court refused to find breaches of the implied covenant of good faith and fair dealing. This case involves a complicated factual setting with respect to the structure of the limited partnerships and their limited partners. Because this decision involved only a motion to expedite the proceedings, a brief overview of the facts relevant to that motion will be discussed.

This summary is provided by Kevin F. Brady and Ryan P. Newell of Connolly Bove Lodge & Hutz LLP.

 

Background

 

Plaintiff Eugene Lonergan, Sr. is the holder of limited partner units (“LP units”) in Enterprise GP Holdings, L.P. (“Holdings”). Holdings, which is the Partnership’s general partner, is a publicly traded master limited partnership (“MLP”). Holdings entered into a proposed merger (the “Proposed Transaction”) with Enterprise Products Partners L.P. (the “Partnership”), which Holdings controlled by virtue of its 100% ownership in the Partnership’s general partner. Lonergan brought a motion to expedite his action to enjoin the Proposed Transaction. Under the Proposed Transaction, Holdings will merge into a subsidiary of the Partnership – in essence, “flattening” the two-tier MLP structure. In the end, Holdings GP will still have control over the Partnership. 

Because there were a number of potential conflicts of interests between Partnership and Holdings, the Holdings GP board of directors formally delegated to the Audit Committee full power to negotiate and accept or reject any deal. Discussions about the Proposed Transaction began in the summer of 2010 and a deal was announced on September 7. A preliminary Form S-4 was filed on September 16. Less than two weeks later, Lonergan filed his complaint and moved for expedited treatment of his petition for preliminary injunction.

 

Allegations – Fiduciary Duty or Implied Covenant?

 

The Court characterized the complaint as “seeks[ing] to cloak familiar breach of fiduciary duty theories in the guise of the implied covenant of good faith and fair dealing.” The complaint asserted that the defendants had been sued “for their breaches of duties arising under the implied contractual covenant of good faith and fair dealing.” And yet the Court noted that the complaint contained the types of allegations that sound more in fiduciary duty than in contract. For example, the complaint alleged that “the Board of [Holdings GP], which controls and manages [Holdings], failed to conduct an adequate and fair sales process to sell [Holdings] prior to agreeing to the Proposed Transaction” and “[i]n agreeing to a sale without conducting a fair and adequate sales process, gathering information about the Company’s net worth, or soliciting other bids, [the] Individual Defendants are allowing [Holdings] to be purchased at well below the Company’s true value” which sounds like a Revlon claim. See, Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). Moreover, the complaint stated that: “[t]he Proposed Transaction . . . represents a classic case of a party standing on both sides of the transaction. In particular, EPCO and its affiliates own a majority stake in [Holdings] and significant equity interests in [the Partnership] as well, creating divided loyalties that have led to the agreement of [sic] a grossly unfair merger to the detriment of the [Holdings’] minority unitholders,” which sounds like a Lynch claim. See, Kahn v. Lynch Communications Systems., Inc., 638 A.2d 1110 (Del. 1994). 

 

Standard for Expedited Treatment

 

The Court repeated the oft-stated standard that a motion to expedite will be granted where “the plaintiff has articulated a sufficiently colorable claim and shown a sufficient possibility of a threatened irreparable injury, as would justify imposing on the defendants and the public the extra (and sometimes substantial) costs of an expedited preliminary injunction proceeding.”

 

No “Quasi-Reformation” Clawback of Fiduciary Duty Claims

 

As the Court observed, the complaint contained allegations about what should have been done to develop alternatives, negotiate the Proposed Transaction and test its fairness. However, the plaintiff framed each of these theories using the implied covenant of good faith and fair dealing instead of fiduciary duty claims, because the Holdings LP Agreement eliminated in two sections of the Holdings LP Agreement default fiduciary duties in accordance with the authority granted Section 17-1101(d) of the Delaware Limited Partnership Act (the “LP Act”).

 

The Court found that the implied covenant theory cannot be used where the parties have contracted away fiduciary duties. Citing, among other cases, the recent Delaware Supreme Court’s decision in Nemec v. Shrader, 991 A.2d 1120, 1125 (Del. 2010), the Court stated:

 

The implied covenant is not a substitute for fiduciary duty analysis. “The covenant is ‘best understood as a way of implying terms in the agreement’ . . . . Existing contract terms control, however, such that implied good faith cannot be used to circumvent the parties’ bargain, or to create a free-floating duty unattached to the underlying legal documents.” The Court must focus on “what the parties likely would have done if they had considered the issues involved.” It must be “clear from what was expressly agreed upon that the parties who negotiated the express terms of the contract would have agreed to proscribe the act later complained of . . . had they thought to negotiate with respect to that matter. The doctrine thus operates only in that narrow band of cases where the contract as a whole speaks sufficiently to suggest an obligation and point to a result, but does not speak directly enough to provide an explicit answer…. Delaware law “will only imply contract terms when the party asserting the implied covenant proves that the other party has acted arbitrarily or unreasonably, thereby frustrating the fruits of the bargain that the asserting party reasonably expected.” “Parties have a right to enter into good and bad contracts[;] the law enforces both.” When an LP agreement eliminates fiduciary duties as part of a detailed contractual governance scheme, Delaware courts should be all the more hesitant to resort to the implied covenant. Fiduciary duty review empowers courts to determine how a governance scheme should operate under particularized factual circumstances. Although the availability of ex post fiduciary review inherently produces some degree of uncertainty, “there is good reason to suppose it can be efficient.” (citations omitted).

 

No Colorable Revlon or Lynch Claims

 

The Court also stated that both of Lonergan’s claims that Holdings GP failed to conduct an adequate sale and failed to include a majority-of-the-minority vote were mistakenly premised on the notion that “Delaware common law decisions identify particular steps that fiduciaries must follow.” Revlon and its progeny require the Court to employ an enhanced scrutiny that “places the burden on the defendant fiduciaries to show that they acted reasonably to obtain for the beneficiaries the best value reasonably available under the circumstances.” Likewise, Lynch is also a standard of review, not a checklist. It does not require specific transactional steps like a majority-of-the-minority vote, but instead entire fairness is “based on all aspects of the entire transaction.”

 

In this case, the Holdings LP Agreement set up a contractual standard of review, which substitutes for the fiduciary duty analysis. The Agreement established four alternative standards of review. If the Proposed Transaction met any one of the four alternatives, then the transaction would be permitted and “deemed approved by all Partners and shall not constitute a breach of this Agreement….” None of the four alternatives required specific actions by the board. Because the plaintiff failed to plead a colorable claim under the theory of an implied covenant, the Court denied the motion to expedite.

 

Postscript: Prof. Ribstein discusses this case at the end of a post here in which he argues that “Delaware Uncorporate Law Evolves as Escape from Dodd-Frank”. That is, while corporations are subject to increasing regulations, parties using LLCs and the like are being given greater freedom via contracts.

Professor Stephen Bainbridge penned an article, available here, about the corporate governance provisions of the recent Dodd-Frank Act.  Among other reasons for reading the article, it should be worthwhile for those interested in the issue of how far the Act has encroached (at least by implication) on those aspects of corporate law that traditionally have been controlled by state law.

Professor Steven Davidoff provides scholarly commentary here on a lecture that Professor Joseph Grundfest recently presented to the Delaware Bench and Bar, as described here, that provides corporations a method to choose Delaware as the forum for intracorporate disputes. Several major corporations have recently included enabling provisions in their organizational documents in connection with what appears to be an increasing trend to make Delaware their choice of forum either in their certificate of incorporation or bylaws. This may counter another trend (according to some commentators), referenced here, in which suits are increasingly being filed outside of Delaware even when Delaware law controls based on the internal affairs doctrine.

Last week in the Barnes & Noble case, the Court of Chancery ruled from the bench that a motion to dismiss would be denied due to questions about the independence of the members of the board that made decisions about a disputed transaction. Professor Steven Davidoff discusses the factual background and legal aspects of the decision, with a link to the transcript here.

 The good professor notes in his analysis that the nuances and the gray areas on this topic make it less than predictable whether a particular person will be deemed independent for purposes of the "demand futility" analysis and Rule 23.1 based on such matters as "social ties" and how often someone plays golf with a person whose decision he is reviewing, for example.