Non-Compete Clause Not Enforced Due to Prior Breach of Employer

A recent Delaware Court of Chancery decision is helpful for anyone seeking to defend or enforce a non-compete agreement that prohibits a former employee from competing with her former employer. In the case of Physiotherapy Corporation v. Moncure, C.A. No. 2017-03960-TMR (Del. Ch. Mar. 12, 2018), the court refused to enforce a non-compete provision against a former employee, based on the prior material breach of the applicable agreement by the former employer.

Key Principle

On a purely contractual level, there is nothing groundbreaking or new about the general principle of contract law that: “If plaintiff is first guilty of a material breach of contract, it may not complain if defendant subsequently refuses to perform.” See footnote 36.  It must be emphasized that the prior breach needs to be material, and a “slight prior breach” by one party may not relieve the other party of his duty to perform.  This general principle has previously been applied in Delaware in actions to enforce a covenant not to compete. See footnotes 36 to 39.


In the facts of this case, the prior employer, after new owners acquired the company, unilaterally and without justification changed the bonus plan that was part of the employment agreement of the employee involved. The failure to fulfill the bonus plan, and the failure to make payments pursuant to that plan, relieved the employee of his obligation under the non-compete provisions due to the prior breach by the employer of the employment agreement. That prior breach was considered material because the amount of compensation went to the essence of the employment agreement.


One could argue that this same reasoning might apply to a common non-compete provision in connection with the sale of a business where the sellers of the business were the key stockholder-managers who are prevented from competing with the new owners of the business. In the instance of an earn-out provision in the acquisition agreement for such a sale that also includes a non-compete provision for key management on the seller’s side, if there is a material breach of the earn-out provision or other material prior breach of the acquisition agreement, and that breach preceded any violation of the non-compete provisions, the same basic contract principles in this decision should arguably apply.


Substantive Changes to Deposition Allowed in Errata Sheet

A recent Delaware Court of Chancery opinion has practical application for anyone involved in depositions as part of their litigation practice. The issue in the case styled Mediacom Delaware LLC v. Sea Colony Recreational Association, Inc., C.A. No. 2018-0003-JRS (Del. Ch. Mar. 13, 2018), was whether a substantive change in a deposition can be made by means of the Errata Sheet submitted by the deponent after the deposition.  Relying on both case law and treatises, the court denied a motion to strike the Errata Sheet of a Rule 30(b)(6) witness. A prior Chancery decision in a different case several years ago, highlighted on these pages, reached a similar result.


The court also relied in part on the wording of Rule 30(e) that expressly allows changes, such as those made via an Errata Sheet, “in form or substance” which the witness desires to make . . .. The court did not regard this issue, based on the facts of this case, as encompassed by the so-called “sham affidavit” doctrine.

The court explained that it has the discretion to strike an Errata Sheet that contains substantive changes to deposition testimony, but based on the circumstances of this case, the court did not view that as necessary in light of the opportunity during an upcoming evidentiary hearing on a motion for preliminary injunction to allow cross-examination of the witness. The court expressly clarified that it was not opining on, and did not want its decision to be interpreted to be a commentary on, the impact of the Errata Sheet on the credibility of the witness–and the court left open the possibility of revisiting its ruling in the event that the deponent was not made available for cross-examination at the upcoming hearing.

This short letter decision should be in the toolbox of every litigator because of its practical application. I know some experienced litigators who pay no attention to the Errata Sheet and do not feel that it is necessary to correct any errors in the deposition transcript–and instead wait for trial to make any corrections.  The letter ruling in this case may be viewed, however, as a factually-based decision not generally applicable in all situations.

Chancery Grants Dissolution of 50/50 Joint Venture

Delaware law allows for a summary proceeding to seek a quick business divorce in certain circumstances. Section 273 of the Delaware General Corporation Law (DGCL) allows for, in essence, a no-fault business divorce if the criteria of the statute are met. Those requirements are that: (i) there are two 50/50 stockholders; (ii) they must be engaged in a joint venture; and (iii) they must be unable to agree upon whether to discontinue the business or how to dispose of its assets. If those prerequisites are met, one of the 50% stockholders can file a petition to dissolve the corporation and request the appointment of a receiver. If the opposing party cannot agree within three months to a plan of dissolution, the court may then take action to appoint a receiver to oversee the dissolution.

Feldman v. YIDL Trust, C.A. No. 2017-0253-AGB (Del. Ch., Mar. 5, 2018), adds to the relatively modest body of case law interpreting Section 273, compared to other sections of the DGCL, but this recent decision of the Court of Chancery provides a helpful addition to this niche of Delaware jurisprudence and explains a set of circumstances that will satisfy the statutory prerequisites for this type of business divorce. As the court instructed:

“The purpose of the statute is to afford relief where the corporation’s two equal shareholders are deadlocked and cannot agree upon whether the joint venture should be continued and how the corporation’s assets should be disposed of.”28 “[W]hile Section 273 recognizes a power in this court to deny a petition that satisfies its minimum standards, such power should be sparingly exercised.”29 “Once the requirements of § 273 are met, the exercise of such discretion is limited to a determination of whether or not a bona fide inability to agree exists between the two shareholders.”30

The sole corporate asset was a boat, and the only two directors were not able to get along. As the court described the key facts: “… they have disagreed about the proper use of the Boat and the allocation of costs and expenses associated with ownership and maintenance of the Boat.” The court further reasoned, in the context of granting the motion for summary judgment to appoint a receiver, that the two 50/50 stockholders:

indisputably have been engaged in a joint venture (owning the Boat) since January 2016 and, as noted above, there is no dispute that they have been unable to agree as to the continued operation of the Company or how to dispose of its sole asset. Although the Trust disputes Benjamin’s ownership of 50% of Royston, I find for the reasons explained below that there are no genuine issues of fact as to his ownership.

About a dozen prior Delaware decisions applying Section 273 have been highlighted on these pages over the last 13 years. In some of those cases, the 50/50 ownership requirement was not satisfied, for example. In others, the Court determined that there was not a sufficient impasse. Analogous cases involving LLCs have been covered as well. Ultimately, the Court has discretion in this version of corporation litigation regarding whether or not to grant the relief requested.

Court Denies Application for Interlocutory Appeal or Alternatively Entry of Partial Final Judgment Pursuant to Rule 54(d).

This post was prepared by Justin M. Forcier, an associate in the Wilmington, Delaware office of Eckert Seamans.

The recent decision of the Court of Chancery in REJV5 AWH Orlando, LLC v. AWH Orlando Member, LLC, C.A. No. 2017-JRS (Del. Ch. Feb. 28, 2018), is a reminder of how rarely interlocutory appeals are granted.

Background: This dispute arises out of a limited liability agreement (the “Agreement”) that both Plaintiff and Defendant entered into in 2015. Plaintiff claims in its complaint that the Agreement grants it an unqualified right to remove Defendant as a manager if Defendant failed to complete a hotel-redevelopment project, which Defendant failed to do. Plaintiff moved for partial summary judgment on the pleadings and the court ruled that Plaintiff’s interpretation was correct under the plain language of the Agreement, but granted Defendant leave to amend its answer. Instead, Defendant filed an application for interlocutory appeal pursuant to Rule 42 and alternatively a motion to enter final judgment pursuant to Rule 54.

Analysis: The court reiterated that interlocutory appeals are only certified by the trial court, then in a separate analysis they are either denied or granted by the Delaware Supreme Court when a “substantial issue of material importance . . . merits appellate review before a final judgment.” And in this matter, the court issued a Status Quo Order that mandated Defendant stay in its position as a manager until the resolution of the case. Therefore, the Court of Chancery held appellate review is not necessary prior to the final resolution of the case.

The court also denied Defendant’s alternative argument–that partial final judgment should be entered based on Rule 54(b).  The court noted that such requests should be granted sparingly. Such an award is only warranted when: (1) the action involves multiple parties or claims; (2) at least one claim or the rights of one party has been fully decided; and (3) there is no reason to delay appeal.

Although the court decided certain issues of contract interpretation in the decision appealed from or alternatively, the subject of a motion for partial final judgment, it did not decide issues of damages or attorneys’ fees that are still pending. Once those issues are decided, the court stated that they should be appealed together. Therefore, the motion for partial final judgment was denied.

Recent Delaware Corporate Governance Scholarship

A recent law review article by a former Delaware corporate litigator, turned law professor, provides timely insights about recent developments in Delaware corporate law regarding the private enforcement of directors’ fiduciary duties. The article is based on a lecture that Professor Randall Thomas delivered a few months ago in Delaware (that is part of a series named after my saintly father, may he rest in peace). With the permission of The Chancery Daily, we offer the TCD’s following overview:

Friday, October 20, 2017, marked the 33rd year of The Delaware Journal of Corporate Law and the Delaware Law School’s Annual Francis G. Pileggi Distinguished Lecture in Law, where Vanderbilt Law School’s Professor Randall S. Thomas posed the question: Is Delaware Retreating? His discussion considered refinement and more or less sudden abrogation in subsequent case law of legal rules announced in four groundbreaking Delaware corporate law decisions: William B. Weinberger v. UOP, Inc., No. 58, 1981, opinion (Del. Feb. 1, 1983); Unocal Corp. v. Mesa Petroleum Co., et al., No. 152, 1985, opinion (Del. June 10, 1985); Revlon, Inc., et al. v. MacAndrews & Forbes Holdings, Inc., Nos. 353, 354, 1985, opinion (Del. Mar. 13, 1986); Blasius Industries, Inc., et al. v. Atlas Corp., et al., C.A. No. *9720-CA, opinion (Del. Ch. July 25, 1988). Today’s edition of The Chancery Daily includes mention of the paper upon which the lecture was based — Delaware’s Retreat: Exploring Developing Fissures and Tectonic Shifts in Delaware Corporate Law (Cox; Thomas) — which in TCD’s view presents a thoughtful, balanced, and cautious view of, in particular, developing aspects of Delaware law, exemplified by the [below] excerpt from the paper’s conclusion.

In our view, there are reasons to be concerned that private enforcement of director fiduciary duties has spiraled out of control, but at the same time, it is important to remember that the new cutbacks by the Delaware courts and legislature will weaken shareholder monitoring of corporate management and potentially increase the incidence of director misconduct.

Cox & Thomas 12/01/2017

Prior Annual Pileggi Lectures in the series have also been highlighted on these pages.

Derivative Suit Dismissed Despite Board’s Failure to Follow Best Practices

The best way to explain the noteworthiness, for those engaged in corporate litigation, of the recent Delaware Chancery decision in Wilkin v. Narachi, C.A. No. 12412-VCMR (Del. Ch. Feb. 28, 2018), is to quote from the Court’s introduction: “This case … is a prime example of the difference between a best practice and a legal obligation  . . . but Plaintiff fails to point to a single legal obligation that directors violated … [and] Plaintiff has not pled facts that give the Court reason to doubt that these [unexpectedly less successful] outcomes stemmed from rational, good faith decisions of faithful, loyal directors.”


This case involved a pharmaceutical company that thought it had a blockbuster drug, but subsequent regulatory and clinical due diligence indicated that the drug would not be as much of a commercial success as originally anticipated. The court explained in this 46-page decision why the complaint failed to plead sufficient facts to show that a majority of the board faced a “substantial likelihood of liability such that they cannot exercise their independent and disinterested business judgment when considering such a [pre-suit] demand.”

The first 23-pages of the decision provide necessary detailed facts that provide the context for the legal analysis, but for purposes of this short overview I will focus on the key legal principles that the Court applies.

This decision is thorough enough to be used as a primer for the prerequisites that a successful derivative action must satisfy in order to survive a challenge under Chancery Rule 23.1.

Basic Delaware Corporate Law Principles Applied:

  • The Court began its analysis with a few basic fundamentals of Delaware corporate governance. Namely, the Court began by explaining that DGCL Section 141(a) empowers directors to manage the business and affairs of the corporation which includes the right to bring all suits on behalf of the corporation.
  • The right of a stockholder to prosecute a derivative suit is an exception to that rule, and the prerequisites that must be satisfied for a stockholder to bring a lawsuit on behalf of the corporation, contrary to the general rule, are mainly as follows: (1) The complaint must allege with particularity that the board was presented with a demand and refused it wrongfully; or (2) That the board could not properly consider a demand thereby excusing the efforts to make demand as futile. See footnotes 113 through 115.
  • The plaintiff in this case only sought to plead demand futility which required the satisfaction of Rule 23.1, which is much more rigorous and requires much more detail than the general notice pleading under Chancery Rule 8(a).
  • Under Rule 23.1, the complaint “must set forth particularized factual statements that are essential to the claim of demand futility. Rule 23.1 is not satisfied by conclusory statements or mere notice pleading, nor is mere speculation or opinion enough.” See footnotes 116 through 119.

Aronson and Rales:

  • The Court reviewed the seminal cases of Aronson and Rales, quoting a recent Delaware Supreme Court decision which explained that both of those cases addressed the same question: “Whether the board can exercise its business judgment on the corporate behalf in considering demands.” (citing In re Duke Energy Corp., Deriv. Litig. 2016 WL 4543788, at * 14 (Del. Ch. Aug. 31, 2016); see also Kandell ex rel. FXCM, Inc. v. Niv, 2017 WL 4334149, at * 11 (Del. Ch. Sept. 29, 2017) (quoting In re China Agritech, Inc. S’holder Deriv. Litig., 2013 WL 2181514, at * 16 (Del. Ch. May 21, 2013)) (“The tests articulated in Aronson and Rales are complementary versions of the same inquiry.”) See footnote 125.
  • Nonetheless, the court described the different procedural context in which Aronson and Rales are usually presented. In order to succeed in a derivative claim that pre-suit demand is excused, the complaint must allege particularized facts sufficient to raise a reasonable doubt that: “(1) The directors are disinterested and independent or (2) The challenged transaction was otherwise the product of a valid exercise of business judgment.” See footnote 123.
  • Under Rales, a derivative plaintiff who does not challenge the actions taken by a majority of the board members considering demand must allege particularized facts sufficient to “create a reasonable doubt that as of the time of the complaint being filed, the board of directors could have properly exercised its independent and disinterested business judgment in responding to a demand.” See footnotes 123 and 124.

Breach of the Duty of Loyalty by Violation of Positive Law:

  • “Because sophisticated and well advised individuals do not customarily confess knowing violations of law, a plaintiff alleging demand is excused under Aronson or Rales because a majority of the board faces a substantial likelihood of liability for breaching of the duty of loyalty by violating positive law, “must plead facts and circumstances sufficient for a Court to infer that the directors knowingly violated positive law.” See footnotes 126 and 127. The Court noted that one way to establish the breach of the duty of loyalty for failure to act in good faith is to demonstrate that the fiduciary acted in a way with the intent to violate applicable positive law.

Demand Not Excused as Futile:

  • The Court explained that pre-suit demand was not excused as futile because even though the complaint alleges that a majority of the board knowingly or intentionally caused the company to violate its obligations and applicable regulations, as well as making improper public statements and breaching confidentiality duties, the Court concluded that “at worst [the board] failed to follow best practices.” Rather, actual knowledge is required to show the directors knew that they were not fulfilling their fiduciary duties. The Court noted that “imposition of liability requires a showing that directors knew they were not discharging their fiduciary duties.
  • But, the Court explained a “failure to follow best practices does not create a substantial likelihood of liability and does not suffice to establish a breach of fiduciary duty.”

Requirements to Establish that a Majority of the Board Faces a Substantial Likelihood of Personal Liability in Order to Excuse Pre-Suit Demand:

  • A prerequisite for successfully pursuing a derivative claim is to demonstrate that there is no reasonable likelihood that the majority of the board could have exercised its independent and disinterested business judgment in responding to a demand.
  • The corollary to that is that a majority of the board must face a “substantial likelihood of personal liability on a claim-by-claim basis. See footnote 31. That requires allegations of conduct that “is so egregious on its face that the board could not have exercised its business judgment in responding to a stockholder demand to pursue those claims.” In essence, the plaintiff must show, for example, that there is a substantial likelihood of liability of a breach of fiduciary duty by, for example, violating positive law.
  • The Court explained in great detail why those prerequisites were not satisfied here, in part, because the complaint did not allege any specific positive law or specific regulations that were violated. Therefore, there was no substantial likelihood of liability of the directors.

Allegations of False Disclosures to Stockholders:

  • The Court explained the important fiduciary duty of accurate disclosures to stockholders with or without a request for stockholder action. See footnote 155.
  • The Court observed that the issue in this case was not whether the directors breached their duty of disclosure, see footnote 157, but instead whether they breached their more general fiduciary of loyalty and good faith by knowingly disseminating to the stockholders false information about the company.
  • Relying on the Delaware Supreme Court decision in Malone v. Brincat, 722 A.2d 5 (Del. 1998), the Court explained that a directors’ duty of disclosure, absent a request for stockholder action, must still include: (1) reliance; (2) causation and; (3) damages.
  • Malone explained that when shareholder action is absent, the need to show reliance, causation and damages was intended to be consistent with similar federal standards. See footnotes 160 and 161.
  • The complaint in this case failed to satisfy those elements of the disclosure claim and therefore the directors would not face a substantial likelihood of liability for breach of the duty of loyalty in that regard.
  • The Court explained that the complaint in this case did not plead a single fact related to the element of reliance.
  • Moreover, without an allegation of reliance, prior Delaware case law explains that a plaintiff cannot rely on a “rebuttable presumption of reliance”, sometimes described as the “fraud on the market theory.” See footnote 175.
  • Thus, the directors did not face a substantial likelihood of liability for knowingly allowing the dissemination of false information to stockholders.

Failure to Exercise Valid Business Judgment:

  • The Court explained why it is so difficult to establish that pre-suit demand is excused due to the failure to exercise valid business judgment.
  • The board explained the bedrock Delaware corporate law principle that: “A board of directors enjoys a presumption of sound business judgment and its decisions will not be disturbed if they can be attributed to any rational business purpose.” Moreover, the Court will not substitute its own notions of what is sound business judgment and importantly: “rationality is the outer limit of the business judgment rule” which may be the functional equivalent of the waste test. See footnote 183.
  • The Court explained that it cannot reasonably conclude that there was no legitimate business purpose for the disclosures that were alleged to be problematic.
  • In conclusion, the Court reasoned that the plaintiff failed to plead particularized facts to show that the directors’ actions were “so egregious or rational that it could not have been based on a valid assessment of the corporation’s best interests.”
  • Therefore, the motion to dismiss was granted.

POSTSCRIPT: This opinion serves as a primer of the basic prerequisites and the high threshold that must be met to successfully pursue a derivative claim in terms of the specific facts that must be alleged before the Court will allow a claim to proceed against directors.

SUPPLEMENT:  Professor Bainbridge has provided a scholarly analysis of this decision and also kindly quotes from this post. 

Chancery Grants Books and Records Request Based on Allegations in DOJ Complaint

This post was prepared by Brian E. O’Neill, Esq. of Eckert Seamans.

The Court of Chancery recently granted a Section 220 request for corporate records based almost entirely upon allegations contained in a complaint lodged by the U.S. Department of Justice (“DOJ”) against UnitedHealth., in the matter of In re UnitedHealth Group, Inc. Section 220 Litigation, C.A. No. 2017-0681-TMR (Del. Ch. Feb. 28, 2018).

Background: In July 2017, a former senior executive of a UnitedHealth subsidiary filed a qui tam action under the False Claims Act against UnitedHealth for its alleged pervasive practice of defrauding Medicare. In his qui tam complaint filed in the United States District Court for the Central District of California, the former executive accused UnitedHealth of “up-coding” patient risk data and failing to delete incorrect diagnoses, which resulted in overpayments from Medicare.

The DOJ intervened in the qui tam action, and alleged that UnitedHealth had violated Medicare regulations and provisions of the False Claims Act for a period of twelve years.

Three entities with a long record of stock ownership in UnitedHealth (“Stockholder Plaintiffs”) filed a Section 220 action in the Court of Chancery to investigate: (1) mismanagement by the directors and officers of UnitedHealth; (2) possible breaches of fiduciary duties by the directors and officers; and (3) the independence of the board of directors, including whether pre-suit demand would be futile.

Analysis: The Court of Chancery noted the familiar standard that a stockholder may inspect the books and records of a Delaware corporation for any “proper purpose.” A proper purpose includes the investigation of corporate mismanagement. The stockholder bears the burden of proof in the Section 220 action, but need not establish corporate misconduct by a preponderance of the evidence to prevail. Instead the Section 220 plaintiff must show “some evidence” to suggest a “credible basis” from which the court may infer corporate misconduct.

The Stockholder Plaintiffs asserted at trial that the voluminous documents obtained by the DOJ in the qui tam action demonstrated that the CEO, several other executives, and directors of UnitedHealth were aware of the Medicare reporting issues and other indicia of corporate misconduct. The Stockholder Plaintiffs contended that such evidence more than supported a credible basis for the court to infer wrongdoing.

UnitedHealth argued that the Court of Chancery should deny the books and records request because it is inappropriate for a Section 220 claimant to base its entire claim on the fact that others have sued the corporation. Defendant also contended that the California District Court was considering a motion to dismiss the DOJ’s complaint, and that the 220 Complaint should be stayed pending resolution of the motion to dismiss.

Vice Chancellor Montgomery-Reeves rejected Defendant’s arguments in this post-trial ruling. The Court noted that unlike Graulich v. Dell, Inc. (summarized previously on these pages), in which the Court of Chancery denied a books and records request, the instant action alleged far more evidence of corporate misconduct. Notably, the Court found that the DOJ recovered documents from UnitedHealth which reflected direct communications among UnitedHealth executives and directors acknowledging the occurrence of pervasive misconduct, as well as depositions of over twenty employees of Defendant.

Accordingly, the Court of Chancery granted the Stockholder plaintiffs’ books and records request. In so ruling, the Court specifically rejected Defendant’s “invitation to make merit-based determinations on whether Defendant’s behavior is actually wrongful or violates the law.” Although granting broad relief to the Stockholder Plaintiffs, the Court denied their request for email communications from certain high-level executives of Defendant because “email communications are more the exception than the rule” in a Section 220 action.

Takeaway: The Court of Chancery will sustain a Section 220 Complaint based on the allegations of a separately filed complaint against a corporation when there is evidence suggesting a credible basis of corporate misconduct.

Chancery Explains Stockholder’s Rights to Obtain Corporate Records

A recent decision of the Delaware Court of Chancery explained the well-established case law that has been developed over many decades to define the contours and nuances of DGCL Section 220, which is the basis for a qualified right of stockholders to demand certain records from a corporation. Many of those Section 220 decisions over the last decade have been highlighted on these pages. In KT4 Partners LLC v. Palantir Technologies, Inc., C.A. No. 2017-0177-JRS (Del. Ch. Feb. 22, 2018), the Court determined that a stockholder satisfied the prerequisites of Section 220 to obtain certain corporate records, notwithstanding other pending litigation in California in which the company is claiming that the stockholder stole trade secrets. Bloomberg posted an article about this ruling.

This 50-page decision can serve as a primer for the requirements of Section 220–including those that have been imposed over the years by judicial gloss even though they cannot be found in the words of the statute. On a procedural level, through no fault of the court, this post-trial ruling came about a year after the complaint was filed, though the court’s guidelines suggest that trial in a Section 220 case might take place in about 90 days from the date of the complaint being filed. There were several complications of the parties’ making that caused the protracted timeline, though prior commentary on Section 220 cases on these pages demonstrates that, despite the apparent simplicity of the statute, these cases can be expensive and time-consuming without much to show for a win.

Anyone seeking to employ rights contained in Section 220, or defend against a Section 220 claim, would be well-served to read this opinion. Assuming a basic familiarity by the reader with Section 220, a few noteworthy aspects of this decision include the following bullet points:

  • The prerequisites of a Section 220 demand must be satisfied in the demand letter, prior to suit, and can’t be fixed in the complaint. Stated another way, the pre-suit Section 220 demand letter in this case did not clearly state a purpose of valuation. Even though that is a recognized “proper purpose”, because that purpose was not stated in the letter, it could not be argued in the complaint or presented as a purpose at trial.
  • An exception to the rule that the stockholder has the burden to prove a “proper purpose”, is when a stockholder seeks to inspect stocklists or stock ledgers pursuant to Section 220(c)–in which case the corporation has the burden of proof to establish an improper purpose. See footnote 75.
  • Investigation of alleged wrongdoing, waste or mismanagement is a recognized “proper purpose” for a Section 220 demand. In this case, that purpose was clearly stated in the pre-suit request along with a satisfaction that there be a “credible basis” to the claims of mismanagement or wrongdoing.
  • The court explained that the purpose must relate to one’s status as a stockholder and not for personal vendettas, for example.
  • This requirement necessitated that the court “thread the needle” involving the company’s defense that the Section 220 demand was an attempt to obtain “early discovery” in the pending litigation between the parties in California, as well as other suggestions that the “primary” purpose was other than the stated purpose. It remains well-settled in Section 220 jurisprudence, however, that as long as the primary purpose is proper, the secondary purpose is not controlling. That determination, of course, is intensely factual–which explains why this opinion is 50-pages long.
  • The failure of the company to hold an annual meeting supported the stockholder’s claimed purpose to investigate wrongdoing and mismanagement.
  • The “credible basis” standard was not met regarding claims that the company thwarted a potential transaction to sell the private company, that would have given stockholders liquidity, and also rejected as a “personal claim” (not a “proper purpose” under Section 220) that the company interfered with his efforts to sell his own stock.
  • The scope of the requested documents was tailored by the court with “rifled precision” to include only those documents essential to address the crux of the stated purpose.

Court Imposes Penalties for Failure to Fulfill Discovery Obligations

The Delaware Court of Chancery recently issued a decision that should be required reading for any lawyer that practices before it, whether they be Delaware counsel or non-Delaware counsel admitted pro hac vice, and whether they engage in corporate and commercial litigation or other types of cases before the court.  In the matter styled: In re Examworks Group, Inc. Stockholder Appraisal Litigation, Cons. C.A. No. 12688-VCL (Del. Ch. Feb. 21, 2019), the court explained in a heavily footnoted and scholarly analysis how serious the court regards scheduling orders, pretrial deadlines, discovery obligations, and the importance of properly-prepared and timely-submitted privilege logs.

For the last 13 or so years that this blog has highlighted key decisions from the Delaware Court of Chancery, the purpose has been to provide noteworthy excerpts from important decisions that are of practical application to lawyers who toil in the vineyards of the Delaware courts.

I have intentionally avoided using names of counsel involved in this case, and have focused on the “nuggets” of the court’s ruling that a busy litigator would need to know. I provide bullet points of the most noteworthy statements of law and the principles emphasized in this decision that should be memorized by any practitioner in the Court of Chancery who seeks to avoid the types of penalties that were imposed in this case for the failure to meet deadlines and the failure to fulfill various discovery obligations.

  • The court begins its analysis with the doctrinal underpinning and the public policy rationale for the importance of candor and fair dealing during the discovery process in order to reduce the element of surprise at trial and to insure that a trial decision is the result of a disinterested search for truth from all available evidence.
  • The court reminded parties that scheduling orders are “not merely guidelines but have the same full force and effect as any other court order.” See footnote 39.
  • The court bluntly underscored the rule that a “party that disregards the provisions in a scheduling order that govern discovery is engaging in discovery abuse.”
  • The court remonstrated that: “Discovery abuse has no place in Delaware courts, and the protection of litigants, the public and the bar demands nothing less than Delaware trial courts be diligent and promptly and effectively take corrective action to secure the just, speedy and inexpensive determination of every proceeding before them.” See footnote 41.
  • Importantly, the court interpreted Court of Chancery Rule 37(b)(2), based on Delaware Supreme Court decisions, as generally requiring the mandatory award of fees for discovery abuses unless the failure to comply with discovery obligations was “substantially justified.” See Slip Op. at 15-17.
  • One of the several problems that the court addressed was that the production of documents came many weeks after the discovery deadline, and well after the depositions were taken. The court noted that the offending party neither requested an extension of the deadline from the court nor sought an extension by agreement with the other parties in the case.
  • The court rejected with emphasis the argument that because the receiving party did not “nag” or press for the compliance with the discovery deadline, that there should be no penalty for non-compliance. The court refused to allow the offending party to “shift the obligation for compliance” to the other party.

Two Levels of Consequences for Missed Discovery Deadlines:

  • The court described the first level of consequence for misconduct involved as including the actual prejudice that resulted from the belated production of documents that the company could have used in discovery for depositions and with their experts.
  • The second level of prejudice involves the “degradation of the litigation process.” The court explained that in order for the litigation system to function, the parties must follow the rules.
  • The court’s reasoning on this point deserves a block quote:

“If participants suspect that others are not following the rules, then the process deteriorates. People who follow the rules feel like chumps when others seem to be cutting corners or breaking rules and getting ahead. People who otherwise might not think of pushing limits become more aggressive if they think everyone else is doing it. It is this broader, systemic interest that the Delaware Supreme Court seems to have had in mind when stressing the courts must address discovery abuse not only to protect litigants, but also to protect the public and the bar.” See footnote 57.

  • The foregoing rationale is one of the best articulations of the need for the courts to enforce discovery obligations so that those who don’t follow the rules gain some advantage, and those who do follow the rules feel, in the words of the court, “like chumps.”

Penalties Imposed

  • The penalty that the court imposed for the substantially tardy production of documents was that the offending party that missed the production deadline was required to produce their witnesses again for deposition and pay for the cost of the depositions, or as the court described it, “bear all expenses associated with their late production of documents and the remedy imposed by this decision.” The court listed in an extended description the types of additional efforts that would be included in the fees that the offending party would be responsible for.

Privilege Logs:

  • Although many prior Chancery decisions have described in detail the importance of privilege logs and the specific components required to be included in privilege logs, as well as the penalty of waiver if the contents of the privilege logs are not sufficient, this opinion provides an additional reminder for those who might not have gotten the message in prior decisions.

For example, the court emphasized that:

  • Producing a timely privilege log is part of a party’s obligation when asserting privilege. The privilege logs must be produced by the same deadline as the date for documents to be produced.
  • The burden of establishing privilege rests on the party asserting it. See footnote 61.
  • The court emphasized that: “An insufficiently supported claim of privilege can result in waiver.” See footnote 63 for cases supporting that well-established statement of Delaware law. Those cited cases also describe the detailed contents that a privilege log must include in order to avoid waiver.
  • The court explained that: “Just as you can’t hit what you can’t see, you can’t challenge what the other side has hasn’t described.” That is, the privilege log must provide sufficient information to enable the adversary to “assess the privilege claim an decide whether to mount a challenge.”
  • The court reiterated Delaware law that: “Producing a privilege log after the discovery cutoff prevents the opposing party from evaluating the log, making timely challenges, and using the resulting documents in discovery. Producing a post-cutoff log has the same effect as not producing a log, which is the same thing as not providing any support for a claim of privilege. Improperly asserting a claim of privilege is no claim of privilege at all.” See footnote 57 (cases collected).


  • In sum, the court gave the party who did not receive the documents on time leave to conduct supplemental depositions to explore any materials produced after the depositions were taken, or as a result of the penalties imposed by this decision. The court imposed on the offending party the cost of the supplemental depositions of its own representatives, as well as the additional costs of additional efforts incurred as a result of the late production, as more specifically described in the opinion.
  • This opinion should be required reading for anyone who practices before the Delaware Court of Chancery, especially out of state counsel who are admitted pro hac vice, in order to “bring home” the importance that the court places on timely compliance with discovery deadlines and discovery obligations, as well as the severe and costly penalties that the court will impose, on a mandatory basis, if those discovery deadlines and obligations are not complied with properly.

POSTSCRIPT: Several years ago, a Delaware Supreme Court opinion was highlighted on these pages, addressing a related issue of what penalties are appropriate for missing pretrial deadlines. See Christian v. Counseling Resource Associates, Inc., Del. Supr., No.  460, 2011 (Jan. 2, 2013) (revised March 26, 2013).

Advancement Claim Partially Denied Based on L.P. Agreement

A recent decision by the Delaware Court of Chancery contrasted the difference between advancement rights based on an L.P. agreement as compared to the right of a corporate director or officer to receive advancement of fees and costs to defend a lawsuit. In Weil v. VEREIT Operating Partnership, L.P., C.A. No. 2017-0613-JTL (Del. Ch. Feb. 13, 2018), the court also distinguished between the different procedural and substantive aspects of an indemnification claim as compared to an advancement claim. This opinion provides important statements of the law and nuances of practical value to those engaged in this frequent subject of Delaware corporate and commercial litigation.

Also, unlike the claims in the context of an alternative entity such as an L.P. agreement, Delaware General Corporation Law (DGCL) Section 145 provides certain “default boundaries” that are not necessarily applicable to an advancement claim based on pure contract terms in the L.P. context. Unlike rights based on an L.P. agreement, generally speaking, once there is an advancement right in the corporate context, DGCL section 145 imposes certain restrictions on the corporation that attempts to deny those rights. See, e.g., one of the three decisions in the Holley v. Nipro cases highlighted on these pages. The Holley decisions provide helpful basic and nuanced principles on this topic.

For those who need to know the latest iteration of Delaware law on advancement and how it differs from indemnification in the L.P. context, this 37-page opinion with over 70 footnotes is required reading. For purposes of this short blog post that is intended for busy corporate litigators, I provide highlights of the decision:


  • The procedural context of this case was a motion for summary judgment which featured 55 exhibits. There were multiple parties involved and several different entities–only some of whom were entitled to advancement or indemnification under the applicable alternative entity agreements.
  • Because this advancement claim was based on an alternative entity agreement, as opposed to corporate documents that were subject to the default constraints of DGCL section 145, the primary framework of the analysis was contractual and not statutory. The court provides a comprehensive review of the detailed factual setting which is necessary to grasp for a complete understanding of the case.

Key Legal Principles:

  • The court referred to Section 17-108 of the Delaware Revised Uniform Limited Partnership Act which gives a limited partnership the power to indemnify any partner or other person, and also includes an empowerment to provide for advancement. Section 17-108 defers completely to the contract of the parties to create rights and obligations with respect to indemnification and advancement of expenses.
  • Importantly, Section 17-108 of the LP Act gives limited partnerships wider freedom of contract to draft their own framework for indemnification and advancement than is available to corporations under Section 145 of the DGCL, which creates mandatory indemnification rights for corporate indemnities in some circumstances–and also bars indemnification in others. See footnote 8 for supporting cases.
  • The court provided a thorough contractual analysis of the advancement and the indemnification provisions in the LP agreement. The court noted the tension and lack of consistency in the LP agreement between the provisions for advancement and the legally quite distinct conceptual analysis of indemnification. The agreement here appeared to describe differently those covered by advancement and indemnification.
  • The court emphasized the important distinctions between an analysis for advancement, which is a summary proceeding where the only question involves the extension of credit, and a completely separate procedural and substantive analysis of indemnification.
  • In advancement cases, when there is an issue whether someone is sued in a covered or non-covered capacity, the court will generally resolve the doubt in favor of advancement, and defers until the subsequent indemnification analysis whether or not the advanced funds might later be subject to disgorgement if a party is later determined to be ineligible for indemnification. See footnotes 20 through 23.
  • The court distinguished the case of Fasciana v. Electronic Data Systems Corp. (“Fasciana I”) 829 A.2d 160 (Del. Ch. 2003), because that case dealt with the determination of who was a “agent” for indemnification purposes under Section 145, but this case focuses on advancement.
  • Based on the contractual basis on which the advancement claims were made in this case, the court analyzed and applied the defined terms, whose definitions were not the model of clarity. See footnotes 28 and 29 and accompanying text.

Specific Disputes About Allocation of Which Fees are Covered

  • Although the parties seemed to acknowledge that there was a right to some advancement, the challenges were based on whether or not all of the fees demanded were properly allocated among covered and non-covered proceedings, as well as covered and non-covered persons.
  • Consistent with prior case law, the court explained that the court will not engage in a line by line review of bills to determine if allocation was proper between covered and non-covered persons or proceedings, and will rely on the certification of senior counsel involved at the advancement stage of the proceedings.
  • The court will wait for the indemnification stage to determine a more specific allocation of what fees were incurred for covered parties and which would be allocated to non-covered parties. See footnotes 33 to 39 and accompanying text.
  • Nonetheless, the court emphasized that an effort must be made to allocate fees, to the extent possible, between those incurred for covered persons and underlying covered proceedings, and those fees incurred for persons or proceedings that are not covered by advancement. See footnote 40.

Unilateral Imposition of Conditions to Payment Rejected:  

  • This is an important principle that should have widespread application even outside the alternative entity context: A company cannot unilaterally impose conditions on advancement that are not contained in the underlying documents on which advancement is based. For example, in this case the court rejected efforts by the company to impose a litigation budget or impose billing guidelines as a condition for advancement because those conditions were not included in the advancement provision of the LP agreement. See footnotes 46 to 48 and accompanying text.
  • Likewise, the court rejected an argument that a company could refuse to pay for annual increases in hourly rates. No such limitation was in the L.P. Agreement.
  • Regarding invoices from third-parties, the court determined that at the advancement stage, it was sufficient to rely on the verification of a senior attorney involved that those invoices were necessary and reasonable.

Reasonableness of Total Fees:

  • The limited partnership agreement allowed for advancement of “reasonable expenses.” Consistent with Court of Chancery Rule 88, as well as Delaware Lawyers’ Rule of Professional Conduct 1.5(a), the court explained that the fees requested must be reasonable in amount based on the eight factors applied under Rule 1.5(a) to make that determination.
  • Nonetheless, the court will not review each line item or time entry and disbursement, nor will it second-guess the judgment of lawyers on the appropriate staffing of the case at the advancement stage.
  • The parties do not have a blank check in this context, however, and the amount of fees are subject to review again at the indemnification stage. The court also observed that the client should also serve as a level of review because until indemnification is decided, that person incurs the risk that the fees may need to be paid back.
  • Regarding the challenge to the rates charged by staff attorneys, the court found that there were factual issues that could not be resolved at summary judgment stage.
  • Regarding allegations that the hours worked on the case were excessive and that the Paul Weiss firm overstaffed the matter, the court determined that it would rely on a certification from a senior partner of Paul Weiss by sworn affidavit that the amount of fees and expenses were reasonable under the circumstances.
  • The court emphasized however that the firm does not have a blank check and that the person receiving the advancement has an incentive to monitor those bills in the event that it may be ultimately determined that the advancement was improvidently granted and may later need to be disgorged. Thus a more detailed review of fees alleged to be excessive is deferred until the indemnification stage, at which time levels of staffing and number of hours worked and rates can be reviewed.

Procedure for Determining Advancement Due on Future Invoices:

  • The court described at pages 32 through 37 of the slip opinion the detailed procedure that the court required to be followed going forward based on the very specific methods described in the Fitracks case which is a very comprehensive procedure designed to minimize the amount of disputes about monthly bills that the court will need to address going forward.

Regarding Fees on Fees:

  • The court determined that because only some of the claims were successful, only a partial amount of fees on fees would be awarded and that the parties should use the same Fitracks procedure to determine those amounts.