This post was prepared by Aimee Czachorowski of the Delaware office of Lewis Brisbois.

The Court of Chancery’s recent Memorandum Opinion in DiDonato v. Campus Eye Management, LLC, C.A. No. 2023-0671-LWW (Del. Ch. Jan. 31, 2024), covers a great deal of ground in addressing a wide variety of defenses raised in connection with a claim under 6 Del. C.  Section 18-110 to confirm whether the plaintiff remained as a manager of the LLC, but of particular interest is the Court’s discussion of whether the defendant should be held in contempt for violating the Court’s status quo order.

The Court explained that Court of Chancery Rule 70(b) provides “broad latitude to remedy violations of its orders” and clearly set forth the requirements for a movant seeking such an order. By a preponderance of the evidence, a movant must show the contemnors violated an order of the Court of which they had notice and by which they were bound and the violation must be a failure to obey the Court in a meaningful way. If that burden is met, the burden then shifts “to the contemnors to show why they were unable to comply with the order.”

After briefing and argument, the Court found the defendant in contempt of its status quo order and, as a remedy, rather than unwinding the transaction at issue, awarded fees incurred by the plaintiff in bringing the motion.    

By: Francis G.X. Pileggi, Sean M. Brennecke, Aimee M. Czachorowski, Rolando A. Diaz, Andrew A. Ralli, Andrew J. Czerkawski, Katherine R. Welch, and Fanta M. Toure

Reprinted courtesy of The Delaware Business Court Insider, ALM Media Properties, LLC, which published this on January 3, 2024.

This is the 19th year that Francis Pileggi has published an annual list of key corporate and commercial decisions of the Delaware Supreme Court and the Delaware Court of Chancery, often with co-authors.  This year’s list does not attempt to include all important decisions of those courts that were rendered in 2023, and eschews some of the cases already extensively discussed by the mainstream press or legal trade publications. This list highlights some of the notable decisions that should be of widespread interest to those involved in corporate and commercial litigation or those who follow the latest developments in this area of Delaware law.

Did Delaware Supreme Court Merge the Blasius and Unocal Standards in Recent Decision of Coster v. UIP Cos., Inc.?

          In Coster v. UIP Companies, Inc., 300 A.3d 656 (Del. 2023), the Delaware Supreme Court approved the Court of Chancery’s combination of Unocal’s nexus test with Blasius’s compelling justification requirement, affirming the holding that:  “To satisfy the compelling justification standard, ‘the directors must show that their actions were reasonable in relation to their legitimate objective, and did not preclude the stockholders from exercising their right to vote or coerce them into voting a particular way.”  The Court of Chancery, noting the case’s “exceptionally unique circumstances,” articulated that “in this context, the shift from ‘reasonable’ to ‘compelling’ requires that the directors establish a close fit between means and ends.”  The Delaware Supreme Court agreed, concluding that courts can apply Unocal “with the sensitivity Blasius review brings to protect the fundamental interests at stake—the free exercise of the stockholder vote as an essential element of corporate democracy.”

Did Delaware Supreme Court Merge the Blasius and Unocal Standards in Recent Decision of Coster v. UIP Cos., Inc. | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Supreme Court Clarifies Limits of Judicial Equitable Review of LLC Agreements

          In Holifield v. XRI Investment Holdings LLC, 2023 Del. LEXIS 295 (Del. Sept. 7, 2023), the Delaware Supreme Court upheld an LLC agreement’s incurable voidness provision.  The provision at issue rendered void—not just voidable—any transfers of interest that were in violation of the LLC agreement. The Court emphasized that Delaware law affords parties to alternative entity agreements maximum private ordering and contractual freedom.  Though it rejected the notion that parties must use “talismanic magic words,” the Court concluded that the plain, unambiguous language of the LLC agreement indicated that sophisticated LLC members bargained for an enforceable clause voiding non-compliant interest transfers, incapable of being cured—even by a court of equity.

Supreme Court Clarifies Limits of Judicial Equitable Review of LLC Agreements | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Recent Chancery Decision Clarifies Basis for Judicial Dissolution of LLC

          In In re Dissolution of T&S Hardwoods KD, LLC, 2023 Del. Ch. LEXIS 16 (Del. Ch. Jan. 20, 2023), the Delaware Court of Chancery clarified what kind of allegations seeking the dissolution of an LLC suffice to pass muster under the plaintiff-friendly Rule 12(b)(6) standard.  The allegations reflected a “continuing breakdown” in the relationship of the managers.  Moreover, despite the LLC agreement’s broad, general purpose clause (“engage in any lawful activities”), the Court determined the parties could not carry on their specifically contemplated business.  Also, because the LLC agreement’s buy-sell provision failed to offer the parties an equitable exit mechanism, the action proceeded past the motion to dismiss stage.

Recent Chancery Decision Clarifies Basis for Judicial Dissolution of LLC | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Caremark Claims Allowed to Proceed Against Corporate Officer

          The Court of Chancery denied a motion to dismiss a McDonald’s shareholders’ derivative complaint against a company officer, which alleged that the officer breached his fiduciary duty of oversight.  The officer contended that Caremark fiduciary obligations do not extend to Delaware corporate officers and thus did not apply to him.  But the Court disagreed.  Mincing no words, the Court in In re McDonald’s Corp. Stockholder Derivative Litigation, 2023 Del. Ch. LEXIS 23 (Del. Ch. Jan. 25, 2023) wrote: “This decision clarifies that corporate officers owe a duty of oversight.”

Caremark Claims Against McDonald’s

Who Can Represent a Cancelled LLC in Response to a Petition Seeking a Receiver?

          In In Re Reinz Wisconsin Gasket, LLC, 2023 Del. Ch. LEXIS 194 (Del. Ch. May 8, 2023), after a company’s counsel filed a notice of dissolution and cancellation, the Court of Chancery prohibited a cancelled LLC from “participat[ing] in the process of appointing its own receiver or retain[ing] counsel to do so.”  The petitioner sought to appoint a receiver and nullify the cancellation.  Opposing the petitioner’s requested relief, Delaware counsel entered appearances on behalf of the company.  Though it granted the request, the Court nevertheless invited the parties “to address the puzzle of a dissolved and cancelled entity appearing to litigate the propriety of its cancellation before they submitted proposed receivers.”

          The Court reflected on the lifespan of an LLC, observing that an LLC’s separate, statutory existence continues until the “cancellation” of its certificate of formation.  Once an authorized person files a certificate of cancellation for the company, “its existence as a jural entity ceases.”  Upon the filing of the certificate of cancellation, “a defunct entity may speak only through a receiver to manage litigation or any other outstanding business: the receiver is appointed because there are no other fiduciaries to make decisions for the entity.”  Finding that a non-existent entity could not retain counsel, and considering it a “metaphysical wonder,” the Court determined: “Counsel’s purported representation of a defunct limited liability company is not only puzzling, but impossible.”

Who Can Represent a Cancelled LLC in Response to a Petition Seeking Receiver? | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Delaware Court of Chancery Provides Guidance on Standard for Awarding Mootness Fees

          In the runup to a merger, a shareholder plaintiff challenged the “don’t, ask don’t waive” provisions in the company’s confidentiality agreements with the bidders by contending that the proxy statement contained materially deficient descriptions.  In Anderson v. Magellan Health, Inc., 298 A.3d 734 (Del. Ch. July 6, 2023), following the suit’s commencement, the company (i) waived some of its confidentiality rights and (ii) supplemented its proxy statement, further detailing the “don’t ask, don’t waive” provisions.  The supplemental disclosures mooted the shareholder litigation.  In the wake of the merger, shareholder plaintiff’s counsel petitioned the Court of Chancery for a $1.1 million fee award.  The company challenged the petition’s “eye-popping” size.

          Thoroughly reviewing the jurisprudential shift in M&A strike suits, the Court opined that going forward, “unless a higher authority proclaims otherwise . . . I will award mootness fees based on supplemental disclosures only when the information is material.”  Nevertheless, the Court found it “unjust” to immediately apply that standard: Delaware courts had yet to apply it and neither the company nor the petitioner briefed it.  Using only the “helpful” standard, the Court found the supplemental proxy disclosures “marginally helpful” and, “[p]utting it all together,” awarded plaintiff’s counsel a $75,000 fee.

Delaware Court of Chancery Provides Guidance on Standard for Awarding Mootness Fees | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Fee-Shifting in Section 220 Case Provides Cautionary Tale

          In Seidman v. Blue Foundry Bancorp, 2023 Del. Ch. LEXIS 178 (Del. Ch. July 10, 2023), concerned over a potentially excessive director and management equity incentive plan, a shareholder demanded to inspect the company’s consulting reports and formal board materials in connection with the equity plan pursuant to DGCL § 220. The shareholder asserted purposes of “investigating mismanagement and communicating with Plaintiff’s fellow stockholders regarding any proxy contest or other corrective measures.”  Claiming the shareholder lacked a proper inspection purpose, the company rejected the demand and refused to produce a single document. The Court had a much different view of the matter.

          Emphasizing the exception to the American Rule under which the Court may discretionarily shift fees “where equity requires,” the Court noted: “To capture the sorts of vexatious activities that the bad-faith exception is intended to address, this court employs the ‘glaringly egregiousness’ standard.”  Decrying “overly aggressive litigation strategies” in the books and records context and highlighting the company’s less-than-scrupulous tactics, the Court concluded: “After [the company] declined to produce a single document to Plaintiff, forcing him to commence litigation, [the company] took a series of litigation positions that, when viewed collectively, were glaringly egregious.”  Accordingly, “[j]ustice” required fee shifting to mitigate such “serious ‘vexatious behavior.’”

Recent Chancery Decisions Provide Cautionary Tales in Section 220 Matters | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Chancery Addresses Fiduciary Duty of Disclosure in Context of a Squeeze-Out

          In Cygnus Opportunity Fund, LLC v. Washington Prime Group, 302 A.3d 430 (Del. Ch. Aug. 9, 2023), after an LLC controller and board of managers squeezed-out the minority unitholders, a group of hedge fund plaintiffs challenged certain disclosures in connection with the merger and a preceding tender offer.  The Court of Chancery dove deep into Delaware’s disclosure jurisprudence in the context of what the Court referred to as the “stockholder-action duty.”  Because Delaware law “piggybacks on the federal [securities] disclosure regime,” the Court entertained the notion that “[i]f a controlling stockholder or third party makes a tender offer for the corporation’s shares, then depending on the circumstances, the directors might well have a duty to respond.  To the extent officers owe the same duties as directors, the duty could apply to them as well.”  Though the Court could not “hash these issues out at the pleading stage,”  the plaintiffs stated a “conceivable” claim because the officers disclosed nothing in connection with “a severely underpriced” tender offer.

          Moreover, examining the etymology of the word “fiduciary” and its trust law roots, the Court emphasized that “[t]he duty of disclosure is a context-specific duty, and no Delaware decision holds that fiduciaries do not owe any duty in the context of a transaction in which the fiduciaries unilaterally eliminate their investors from an enterprise.”  Because a squeeze-out is such a transaction, “the duty of loyalty could manifest as an obligation to inform the beneficiary of the material facts surrounding the transaction, regardless of whether or not the beneficiary’s approval is required.”

Chancery Addresses Fiduciary Duty of Disclosure in Context of a Squeeze-Out | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Chancery Court finds collection of bad faith factors enough to keep GoDaddy suit alive

          The Court of Chancery, in IBEW Local Union 481 Defined Contribution Plan & Trust v. Winborne, 2023 Del. Ch. LEXIS 342 (Del. Ch. Aug. 24, 2023), allowed a shareholder derivative suit to survive a motion to dismiss because the plaintiff adequately pled demand futility based on the board’s alleged bad faith overpayment to settle an outstanding company liability.  Reviewing Rule 23.1’s doctrinal pillars, the Court examined the pleading standard required to withstand dismissal for want of “reasonable doubt” as to the board’s ability to properly respond to a pre-suit demand.  Focusing on the second prong of Delaware’s demand futility test, the Court considered whether at least three of the directors faced a substantial likelihood of bad faith liability for approving the settlement.

          Noting that “[c]lairvoyance plays no role,” the Court extensively reviewed the precedent detailing how Delaware measures pleadings-stage fiduciary bad faith. In sum: “Properly understood, the good faith inquiry is a holistic one.”  A court of equity can allow a case to proceed past the pleading stage when the allegations as a whole support an inference of bad faith.  The “constellation of factors”—including an almost $700 million disparity between what the company valued the settlement at and what the company actually paid for it—supported a pleading stage bad faith inference sufficient to pass demand futility review.

Chancery Court finds collection of bad faith factors enough to keep GoDaddy suit alive | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Chancery Rejects Request for Specific Performance to Close Deal

          With a factual background that reads like a Hollywood thriller, in 26 Capital Acquisition Corp. v. Tiger Resort Asia Ltd., 2023 Del. Ch. LEXIS 364 (Del. Ch. Sept. 7, 2023), the Court of Chancery declined to compel an acquisition target to close a busted deal.  The acquirer sought specific performance under a de-SPAC merger agreement.  The Court meticulously weighed the factors supporting specific performance after criticizing the sponsor and its hedge fund majority shareholder’s duplicitous behavior.  Refusing to specifically enforce the merger agreement’s reasonable best efforts clause, the Court concluded that the transaction’s troubling factual backdrop disfavored such a remedy.

The Court of Chancery Declines to Save Belly Up de-SPAC

Chancery rules that Delaware allows grant of 10 votes per-share to “Up-C” CEO

          In Colon v. Bumble, Inc., 2023 Del. Ch. LEXIS 367 (Del. Ch. Sep. 12, 2023), the Court of Chancery upheld the validity of a challenged capital arrangement that layered standard Up-C and dual class voting structures into a “bespoke” capital design.  The share classes’ voting power differed depending on the holder’s identity.  If a separately referenced and defined (outside the charter) “Principal Stockholder” held a class A share, then it carried ten votes per share; otherwise, it carried only one.  And if a Principal Stockholder held a class B share, then it carried ten votes per each class A share into which it could convert; otherwise, it carried only one.  Though the Court noted that its opinion did not consider whether such an identity-based governance regime would pass Delaware’s “twice tested” review of corporate action, it concluded the challenged charter provisions and capital structure complied with the Delaware General Corporation Law.

Chancery rules that Delaware allows grant of 10 votes per-share to “Up-C” CEO | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Section 225 Action Determines That Board Members Were Properly Removed

          In Barbey v. Cerego, Inc., 2023 Del. Ch. LEXIS 379 (Del. Ch. Sept. 29, 2023), after a wholly owned foreign subsidiary launched a tender offer to the shareholders of its Delaware parent, resulting in an inversion, the Court of Chancery upheld as valid the removal of the entire parent board.  A shareholder and ousted director challenged the removal under DGCL § 225, contending that the director’s failure to receive the required notice of the meeting at which the board approved the tender offer rendered the approval thereof and subsequent management change void.  The Court agreed, but nevertheless determined that the plaintiffs failed to draw a sufficient connection between the void meeting and the effect of the tender offer.  Noting that the internal affairs doctrine governed whether the foreign subsidiary enjoyed the authority to independently launch the tender offer without the parent’s approval, the Court concluded that the plaintiffs failed to timely meet their burden, and upheld the board’s removal.

Chancery Determines in Section 225 Action: Board Members Properly Removed | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Entire Fairness Test Applied, But No Damages

          The Court of Chancery in In re Straight Path Communications Inc. Consolidated Stockholder Litigation, 2023 Del. Ch. LEXIS 387 (Del. Ch. Oct. 3, 2023),held that a controlling shareholder drove a not-entirely-fair transaction and breached fiduciary duties he owed to the minority.  Yet, the Court found that the transaction, while unfair under Delaware’s “unified fairness review, considering both price and process,” caused the minority no actual damages.  Nevertheless, finding the controller steered the transaction “in a manifestly unfair manner,” the transaction thus “was not entirely fair.”  Pointing out that a claim for breach of fiduciary duties does not require proving actual damages, the Court awarded the minority class nominal damages.

Unfair Process Incurs Nominal Damages Under Entire Fairness Review

Chancellor “X”s out Twitter investor’s claim he spurred Musk’s social media mind change

          In Crispo v. Musk, 2023 Del. Ch. LEXIS 466 (Del. Ch. Oct. 31, 2023), the Court of Chancery declined to award a mootness fee because the plaintiff shareholder filed an unmeritorious claim.  The decision turned on whether a merger agreement’s lost premium carve-out to its general no third-party beneficiaries clause conferred standing on the shareholder seeking damages for the then-failed merger agreement.  Examining the development of lost premium provisions in the M&A space, the Court detailed the unique relationship between Delaware’s board-centric governance paradigm, merger agreements, and shareholder interests.  Invoking Delaware’s hesitance to confer third-party merger agreement standing on shareholders, the Court found the contractual scheme afforded the shareholder plaintiff no third-party beneficiary status, thus rendering his mooted claim unmeritorious.

Chancellor “X”s out Twitter investor’s claim he spurred Musk’s social media mind change | Delaware Corporate & Commercial Litigation Blog (delawarelitigation.com)

Lead Plaintiff Forced to Elect Remedy

          In litigation following a plenary Revlon action (in which the Delaware Court of Chancery awarded damages to a shareholder class after finding the CEO, with a private equity firm’s aiding and abetting, breached his fiduciary duty), in In re Mindbody, Inc., 2023 Del. Ch. LEXIS 575 (Del. Ch. Nov. 15, 2023), the Court concluded that Delaware law permitted the lead hedge fund class plaintiffs, who simultaneously petitioned for appraisal, to elect to receive the merger consideration and class damages remedy.  Because the appraisal-seeking hedge funds shouldered no obligation to “make a binding election as to remedy” before the plenary action’s trial, and the shareholder class included the funds, Delaware precedent allowed them to choose either.  But the Court prohibited a double recovery. If the funds elected to pursue their appraisal petition, they could not receive the class remedy.  Conversely, if the funds elected to receive the class remedy, then the Court would not appraise their shares.

The Court of Chancery Permits Concurrent Plenary Fiduciary and Appraisal Claims

Restrictive Covenants Found Unenforceable

          In Sunder Energy, LLC v. Jackson, 2023 Del. Ch. LEXIS 580 (Del. Ch. Nov. 22, 2023), the Court of Chancery denied a solar power system dealer’s application for a preliminary injunction to enforce restrictive covenants against a former minority member.  The Court found that two of the members surreptitiously procured an amendment to the LLC agreement in breach of their fiduciary duties.  The amendment rendered the resulting minority little more than mere employees and imposed onerous restrictive covenants.  Because the purported majority members breached their fiduciary duties in connection with the amendment, the Court prevented them from enforcing the covenants.  The Court further opined, assuming arguendo their threshold validity, the restrictive covenants failed to “pass muster” under Delaware law.  Reviewing the primary and additional factors governing the enforceability of restrictive covenants, the Court evaluated “all of the dimensions” of the disputed provisions “holistically and in context.”  The Court considered how they operated within the contract as a whole and declined to “tick through individual features of a restriction in insolation, because features work together synergistically.”  With reasonableness as the touchstone, the Court found the “astonishingly broad” restrictions unreasonable and refused to enforce them.

Unreasonable Restrictive Covenants Fail Delaware’s Holistic Review

Rarely Invoked Provision of DGCL Examined

          As one part of a vast, multi-jurisdictional saga between oil giants, in a decision concerning a DGCL provision that is rarely the subject of a judicial decision, the Court of Chancery in Venezuela v. PDC Holding, Inc., 2023 Del. Ch. LEXIS 582 (Del. Ch. Nov. 28, 2023),ordered a wholly-owned Delaware subsidiary to issue a replacement stock certificate to its Venezuelan parent.  The Court detailed the three requirements under section 168 of the DGCL that a shareholder must satisfy to receive a judicially-ordered replacement of a “lost, stolen, or destroyed” stock certificate.  Though the parties did not dispute the typically litigated elements, the subsidiary initially requested the parent post a bond in the neighborhood of $40 billion.  Although the Court lacked power to waive the bond requirement altogether (if the issuer requested one), the Court nevertheless enjoyed discretion to set the amount “based on the circumstances presented in each case.”  After examining the purpose for the bond-as-security requirement and the circumstances surrounding the potential ramifications of reissuing a certificate evincing ownership of the particular shares, the Court found a “nominal, unsecured” bond in the amount of $10,000 appropriate.Chancery Interprets DGCL Section 168 for Replacement Stock Certificate

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.

A Delaware Supreme Court milestone ruling has revived a shareholder suit over pharmaceutical giant AmerisourceBergen Corp.’s role in the nation’s opioid crisis, finding the Court of Chancery should not have dismissed the derivative action by relying on a related federal court decision in  Lebanon County Employees’ Retirement Fund, et al. v. Collis, et al., C.A. No. 22, 2023, Dec. 18, 2023 (Del.).

Justice Gary Traynor, writing the December 18 unanimous en banc opinion that reversed the Chancery’s Dec. 22, 2022 ruling, said the Court of Chancery correctly concluded that the plaintiff pension funds supported charges that the Amerisource directors disloyally exposed the company to $6 billion in liability by favoring profits over people.  Lebanon County Employees’ Retirement Fund, et al. v. Collis, et al., C.A. No. 2021-1118-JTL (Del. Ch. Dec. 22, 2022). But Justice Traynor said the vice chancellor should not have accepted as law a West Virginia District Court’s ruling about facts that were still in dispute concerning director actions. City of Huntington v. AmerisourceBergen Drug Corp., 609 F. Supp. 3d 408, 425 (S.D. W. Va. 2022).

The high court said on that basis, the vice chancellor decided that despite his finding that the board ignored numerous red flag warnings and violated an opioid distribution monitoring pact with the government, the derivative charges must fail the pre-suit demand test because the federal court ruled that the directors faced no individual liability. 

The opinion will likely be studied by corporate law practitioners first because it:

  • Sets parameters regarding when and how to take, weigh and apply judicial notice of the facts and law contained in rulings outside the First State.
  • Updates guidelines to apply to developments in multi-faceted mega-litigation that occur after the filing of the operative complaint in a Delaware derivative suit and how they can be factored into a demand futility decision in that action, and
  • Takes a fresh look at what constitutes potential liability that could prevent directors from objectively evaluating shareholder litigation over whether they have mismanaged and financially damaged their company — known as Caremark claims after the seminal decision in In re Caremark Int’l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996).

Background

AmerisourceBergen, one of three major wholesale distributors of opioid pain medication in the United States over the past two decades, found itself at the center of America’s opioid epidemic and in 2021, agreed to pay over $6 billion as part of a nationwide settlement to resolve multidistrict litigation brought against the three, additionally incurring hundreds of millions of dollars to settle other lawsuits and over $1 billion in defense costs.

Two dismissal motions

According to the court’s record, two pension funds sued in Chancery Court, contending that Amerisource’s directors and officers breached their fiduciary duties by making affirmative decisions and conscious non-decisions that led to the harm that the company has suffered. Plaintiffs sought to shift the responsibility for that harm from AmerisourceBergen to the human fiduciaries who allegedly caused it to occur.  The plaintiffs survived the directors’ motion to dismiss on grounds that the charges were filed too late.  Lebanon County Employees’ Retirement Fund, et al. v. Collis, et al., C.A. No. 2021-1118-JTL (Del. Ch. Dec. 15, 2022).

 But that novel ruling only kept the derivative suit alive for an additional week.  In a December 22 opinion, the vice chancellor agreed with the directors’ argument that under the pre-suit demand futility test, dismissal was justified because a majority of the board was not too conflicted to objectively decide whether the suit had enough merit to go forward.  Lebanon County Employees’ Retirement Fund, et al. v. Collis, et al., C.A. No. 2021-1118-JTL (Del. Ch. Dec. 22, 2022).

The Vice Chancellor found that a federal court in West Virginia, in a related bellwether test case to decide nationwide liability for damages to opioid users, had already ruled that the directors could not be held legally liable for making decisions that directly caused the damage.  He said that federal judge had considered all the evidence and testimony in the opioid damages trial and found insufficient reason to hold the directors individually liable for causing the damages.

A rare reversal

The plaintiffs’ appeal to the Supreme court argued that Vice Chancellor Laster wrongly let the federal opinion sway his decision even though it came after the operative complaint in his case had been filed and the federal court facts he relied on were still in dispute.

In a rare reversal of the Chancery Court, the justices issued the December 18 opinion four days shy of the one-year anniversary of the dismissal ruling. It essentially agreed with plaintiffs on those weight, applicability and timing issues concerning the federal court’s finding of no director liability.

Would have survived

“The Court of Chancery accepted the West Virginia Court’s findings that “‘[n]o culpable acts by defendants caused an oversupply of opioids,” finding that Amerisource  had an adequate anti- diversion program in place and that there was no evidence that it  distributed opioids to pill mills,” Justice Traynor wrote, finding that, “Without the findings, the plaintiffs’ claims would have survived; with them, they perished.” And he found the trial court’s “adjudicative judicial notice of the factual findings” in error.

Proper judicial notice

Moreover, he noted, judicial notice can be properly taken of only undisputed facts and the federal court wrongly concluded that no wrongdoing had occurred for which the defendants might be held liable, which “was, and is, reasonably disputed.”

As to the issue of the timing of the federal court’s liability ruling and the date of the complaint, the High Court stated:  ‘the Court of Chancery’s reliance on the factual findings in the West Virginia Decision changed the date at which demand futility was considered.”  The Justice concluded on behalf of the High Court that, “under the Court of Chancery’s analysis, the plaintiffs established their derivative standing as of the time the complaint was filed.  The court erred by vitiating the plaintiffs’ standing in deference to the factual findings in the West Virginia decision.”

Andrew J. Czerkawski of the Lewis Brisbois Delaware office prepared this post.

          Seeking to compel its Delaware subsidiary to issue a replacement stock certificate evincing ownership of all 1,000 of the subsidiary’s issued and outstanding shares, a foreign parent corporation filed suit in the Delaware Court of Chancery under the rarely litigated DGCL § 168, in Venezuela v. PDC Holding, Inc., 2023 Del. Ch. LEXIS 582 (Del. Ch. Nov. 28, 2023).

BRIEF FACTUAL OVERVIEW

          This action took place as one part of a vast web of internationally connected litigation sagas and geopolitical intrigue.  A non-party Canadian corporation sought to execute on its $1.2 billion international arbitration judgment against a foreign nation.  That nation’s government wholly owned the parent entity which in turn wholly owned all of the instant defendant Delaware corporation’s shares (the subsidiary itself in turn wholly owns one of the largest operating petroleum refining companies in the United States).

          In federal court, the non-party Canadian corporation successfully moved to attach and foreclose on the parent’s shares of its Delaware subsidiary, arguing the parent acts only as an alter ego of the foreign nation.  The federal court eventually ordered the sale of the foreign parent’s shares of its Delaware subsidiary to satisfy the foreign nation’s debt to the non-party Canadian corporation and required the parent to submit its original stock certificate evincing its ownership of the Delaware subsidiary shares.  If the parent could not produce the stock certificate, the order gave the option for the parent to seek the Court of Chancery’s expedited aid in procuring a replacement.  The parent did just that: it filed the instant DGCL § 168 action against its wholly owned Delaware subsidiary to compel the issuance of a replacement stock certificate (the parties aligning interests in connection with the foreign nation did not escape the Court; multiple creditors of the foreign nation filed amici curiae briefs supporting the certificate’s reissuance, pointing to the foreign parent and its Delaware subsidiary’s “repeated acts of recalcitrance” to “slow down the sales process”).

KEY ANALYSIS

          Beginning with the language itself, the Court laid out the Delaware precedent detailing Section 168’s primary requirements, the burden of which rests on the plaintiff to show: (i) the plaintiff demanded corporate management issue a replacement certificate; (ii) management refused the demand; (iii) the plaintiff lawfully owns the complained-of capital stock; and (iv) the original stock certificate “has in fact been lost, stolen, or destroyed.”  If the plaintiff satisfies her burden on these elements, then the rebuttal burden shifts to the corporation to demonstrate “good cause” in opposition to the reissue.  And if the corporation fails to carry its rebuttal burden, then the Court “shall make an order requiring the corporation to issue and deliver to the plaintiff” a new stock certificate.

           The parties left the primary elements virtually undisputed.  But, receiving the lion’s share of the Court’s attention, Section 168 also mandates the plaintiff receiving the new certificate give the corporation an indemnity bond.  Providing the “upper limit of the corporation’s liability for actions arising out of” the reissuance, the plaintiff must first “‘give the corporation a bond in such form and with such security as to the court appears sufficient to indemnify the corporation against any claim that may be made against it on account of the alleged loss, theft or destruction of any such certificate or the issuance of such new . . . certificate.’”

          The defending subsidiary initially requested the plaintiff parent post an indemnity bond “between $32 and $40 billion,” eventually settling on $1 to $2 billion.  Though the amici creditors contended the Court could dispense with the statutory indemnity bond requirement altogether, Delaware precedent held the opposite: if the issuer insists on one, the Court cannot waive the bond and security requirement altogether.

          Yet, the Court enjoys discretion to set the bond’s amount—an amount sufficient “to protect the issuer if the original stock certificate is presented.”  The Court described the reason for the bond requirement: “A bond ‘is necessary because the absence of a certificate constitutes notice to the corporation that a third party might have superior title to the underlying stock and that the corporation could be liable for conversion to one holding the original certificate in good faith under a superior title.’”  But if the issuing party appears to face little to no “cognizable harm,” the Court may set a “nominal bond.”

          Setting the discretionary bond amount required the Court to examine all the circumstances surrounding the low-but-not-zero risk posed to the subsidiary for the reissuance.  The Court pointed to a litany of reasons supporting a nominal, unsecured bond: neither party disputed the parent’s record ownership; unlike a “typical retail stockholder of a publicly traded company seeking a replacement certificate,” the particular certificate represents absolute control over one of the planet’s largest oil companies worth potentially hundreds of billions of dollars—only “Rip Van Winkle” would not know of the shares’ involvement in the tumultuous litigation sagas; no other party had claimed any interest in the shares or certificate; Delaware corporations cannot issue bearer shares, and no party had requested the subsidiary to change its books reflecting a transfer; and no adequate evidence indicated the parent secretly pledged the shares.

          Declining to “suspend disbelief” on an unrealistic threat to the subsidiary for reissuing the certificate, the Court refused to find good cause opposing the reissue and ordered the foreign parent plaintiff to post an unsecured $10,000 bond.

PRACTICAL TAKEAWAY

          Though typically arising these days in connection with a startup or closely-held company, this decision lays out a clean, succinct blueprint for Delaware investors to procure replacement stock certificates.

Andrew J. Czerkawski of the Lewis Brisbois Delaware office prepared this post.

          This litigation followed a recent plenary Revlon action in which the Delaware Court of Chancery awarded damages to a shareholder class after finding the CEO, with a private equity firm’s aiding and abetting, breached his fiduciary duties.  The lead class shareholder plaintiffs in the underlying fiduciary action, a group of hedge funds, simultaneously petitioned the Court to appraise their shares.  The Court in In re Mindbody, Inc., 2023 Del. Ch. LEXIS 575 (Del. Ch. Nov. 15, 2023), consolidated the fiduciary and appraisal proceedings for trial.

BRIEF FACTUAL OVERVIEW

          The challenged merger closed at $36.50 per share.  And after the plenary action’s trial, the Court awarded the shareholder class damages of $1 per share.  The parties, however, disputed how the post-trial decision should play out as a final order; in pertinent part, the parties disagreed over whether the shareholder class plaintiffs could elect to receive the merger consideration and class damages.

KEY ANALYSIS

          The Court examined Delaware’s precedential treatment of shareholders simultaneously seeking both appraisal and fiduciary damages, concluding neither procedurally forecloses the other.

          First, The Court held that it can consolidate both claims as alternatives to one another, but Delaware law does not impose an obligation on the shareholder to elect a remedy before trial—“the opposite result would impose perverse incentives on defendants while disadvantaging potential stockholders who seek to vindicate their rights.”

          Second, the Court noted it can award shareholder class plaintiffs seeking concurrent fiduciary and appraisal claims the remedy of a “‘fairer price.’

          Furthermore, diving deeper into Cede, the Court considered whether electing to receive the class remedy precludes the shareholders from continuing to pursue appraisal: it does. 

PRACTICAL TAKEAWAY

          This decision potentially opens the door (or perhaps keeps the door open) for the more risk averse shareholders, who might not otherwise pursue uncertain, lengthy Revlon fiduciary litigation to hedge some of that risk and allow them to pull the trigger on a litigation strategy that reflects the Court’s opinion.

Andrew J. Czerkawski of the Lewis Brisbois Delaware office prepared this post.

          Minority shareholders of a former publicly traded telecommunications company brought suit in the Delaware Court of Chancery, alleging the controlling shareholder, with the aiding and abetting of the company’s pre-spin-off parent, breached his fiduciary duty of loyalty he owed to the minority.  The lead plaintiff claimed the controller caused the company to unfairly sell a litigation asset in In re Straight Path Communications Inc. Consolidated Stockholder Litigation, 2023 Del. Ch. LEXIS 387 (Del. Ch. Oct. 3, 2023).

BRIEF FACTUAL OVERVIEW

          The prior parent spun off a patent infringement portfolio to insulate itself from potential counterclaims and transferred various IP assets, including a portfolio of broadcast spectrum licenses.  As part of the separation agreement’s stock swap ratio, the prior parent’s founder and chairman became the new company’s controller.

          As a result of a regulatory investigation concerning broadcast spectrum licenses, the company entered into a multi-million dollar settlement with the regulator, consisting of fines and other penalties.  Under the spin-off separation agreement, the company could seek indemnification for those penalties from the parent.  The company’s board considered this indemnification claim a valuable company asset.  The company formed a fully independent special committee to handle the sale of the company’s IP assets and pursue the indemnification claim.  But, as detailed below, the controller usurped the process and used his positional influence to cause an unfair settlement of the claim.

KEY ANALYSIS

          As a threshold matter, the Court determined that the defendant parent’s founder and chairman controlled more than seventy percent of the spun-off company’s voting power.  Similarly, because of the parent’s flagship status and through his familial ownership ties, the company’s release of the indemnification claim against the parent conferred a non-ratable benefit to the controller.  Thus, entire fairness review of the indemnification claim release applied.

          The Court employed the unified entire fairness test, considering the fairness of both the price and the process.  Though it discussed at length the viability of the indemnification claim as a company asset, due to the company’s failure to comply with the separation agreement’s notice and consent requirements, the Court found the indemnification claim “had no economic value.”  Thus, because the parent paid the company $10 million to release an essentially worthless claim, the parent paid a “not unfair” price.

          Yet, the decision highlighted the controller’s “steamrolling” tactics and the “overwhelming evidence of unfair process.”  Reiterating the process factors (timing, initiation, structure, negotiation, disclosures, approval), the Court wrote: “This court is frequently asked to make findings of controller overreach based on only circumstantial evidence, cryptic communications, or inference.  This is not one of those cases.”  The controller “made every effort to bully the Special Committee towards his desired outcome.”

          The Court observed the controller’s “campaign of abuse and coercion.”

          Emphasizing the unified analysis, finding a fair price paid did not end the Court’s decision: “the question is one of entire fairness, and what the stockholders could have achieved, absent the iniquities.”  The Court pointed out its precedent on fair process—“[t]his court has held that a fair price ‘does not ameliorate a process that was beyond unfair.”  The defending fiduciary must satisfy “[b]oth aspects of the entire fairness test – fair dealing and fair price.”  “This assessment provides an opportunity to evaluate the transaction holistically and ‘eliminate the ability of the defendants to profit from their breaches of the duty of loyalty.’”

          Noting that a claim for breach of fiduciary duty does not require the plaintiff shareholder to prove actual damages, the Court found the controller’s “coercion” of the special committee “breached his duty of loyalty to the minority stockholders” and held the controller liable for nominal damages.

PRACTICAL TAKEAWAY

          In disputes challenging the fairness of conflicted controller transactions, fiduciary liability does not live and die on price alone.  Even if the controller forces an otherwise sweetheart deal, the court will still closely scrutinize the manner in which the controller exercised that force.  If the transaction’s process tips the deal’s unfairness past equipoise, then the controller faces nominal damages along with a judicial rebuke.

Andrew J. Czerkawski of the Lewis Brisbois Delaware office prepared this post.

The sponsor of a busted de-SPAC merger asked the Delaware Court of Chancery to order the target to close under the merger agreement’s reasonable best efforts clause, but the Court refused to do so in 26 Capital Acquisition Corp. v. Tiger Resort Asia Ltd., 2023 Del. Ch. LEXIS 364 (Del. Ch. Sep. 7, 2023).

BRIEF FACTUAL BACKGROUND

          A Japanese gaming company parent, through its intervening subsidiary, owned a valuable casino in the Philippines.  A New York-based hedge fund purchased and held a small block in the parent.  After the parent failed to launch an IPO, the fund proposed a de-SPAC merger transaction to the parent’s investor relations manager.  Receptive to the idea, the parent engaged the fund in a formal advisory relationship, in which the fund would facilitate and analyze any potential SPAC deal.

          The fund connected with a potential sponsor and pitched the idea.  But before making introductions, the fund demanded and eventually procured a majority economic interest in the sponsor.  In a series of events too lengthy and nuanced to detail here, the fund worked as a “double agent”—convincing the parent with whom the fund had a formal advisory relationship to accept the deal while feeding inside information back to the sponsor in order to make it happen.

          Meanwhile, an ousted former director of the parent challenged his removal in the Philippines and received a favorable ruling.  The Philippine Supreme Court subsequently issued a status quo ante order.  Though the parties could not decisively determine whether consummating the deal would violate the order, the fund nevertheless continued to push the closing.  The target’s management began to suspect the fund’s deception, which the fund denied.

          A month after receiving the status quo order, the ousted director, with the help of the local police, enacted a violent physical takeover of the casino in the Philippines.  Still, the sponsor and the fund “seemed not to care about the fate of the employees and remained laser focused on closing the transaction.”  After the parent failed to retake the casino via judicial process in the Philippines, a politically oriented “dodgy bargain” occurred.  The Philippine executive branch then stepped in and “declared the takeover illegal,” helping the parent regain control.

          After more clandestine scheming with the fund, frustrated with further extension of the merger, the sponsor filed suit in the Delaware Court of Chancery, seeking to force the target to close.

KEY ANALYSIS

          Delaware law, though “strongly contractarian,” does not categorically require the Court to enforce a reasonable best efforts clause through an order of specific performance.  Rather, granting “[s]pecific performance is a matter of grace that rests in the sound discretion of the court.”  Examining multiple factors, the Court determined that the circumstances disfavored the “extraordinary” remedy of specific performance.

          First, the transaction’s complexity and “associated difficulty of providing meaningful judicial oversight” weighed against ordering the target to close.  The interim steps remaining before closing and the quagmire of factual circumstances counseled against specific performance: preparing audited financial statements; filing a securities registration statement; dealing with the SEC; a foreign gambling corporation; a history of poor internal governance; a physical takeover; likely corrupt political ties; and “exceedingly aggressive” counterparties with “terrible judgment.”

          Second, the operative parties and their assets’ overseas locations, outside the Court’s reach to enforce coercive sanctions, rendered any order compelling the target to close a “nullity.”  The Court opined, “the sun has set on the era in which a nation might send gunboats to enforce a judgment issued by its courts,” also emphasizing that  “Delaware has no blue water navy to send, and the United States Constitution confers authority over international affairs on the federal government, not the several states.”  Acknowledging its own enforcement limitations, the Court further opined, “[t]he court is not dealing with an obstreperous billionaire or other headstrong individual whose body and assets are subject to coercive sanction through the American justice system.  In this case, the defendants are, quite literally, outside the range of the court’s armamentarium.  Firing at such a target just wastes ammunition.”

          Third, the foreign status quo order weighed against ordering the target to close.  If the target did so, it risked violating the foreign high court order, potentially subjecting it to criminal contempt.  Thus, such a consequence counseled against specific performance even under the merger agreement’s reasonable best efforts clause.

          Fourth, the Court considered and thoroughly laid out the sponsor acquiror and its hedge fund majority shareholder’s inequitable conduct.  With no sugar coating, the Court bullet-pointed their duplicitous actions and emphasized that they “acted as partners to gain and exploit their inequitable advantage over” and “engaged in a conspiracy to mislead” the target and its subsidiaries, “the type of conduct that should not be rewarded with a decree of specific performance.”

          Finally, balancing the equities, the Court considered the interests of the acquiror’s unaffiliated shareholders.  But the Court nevertheless determined that its shareholders “cannot truly claim the status of innocent victims.”  Noting that the acquiror’s shareholders “backed” the wrongdoing and “signed up for the ride,” undertaking to “benefit from the gains or suffer the losses that [the sponsor] and his team delivered,” the Court refused to allow the sponsor to “wrap itself in the mantle of its stockholders to pretend that none of the events described in this case ever happened.”  The sponsor and its hedge fund majority stakeholder tried to persuade the Court that “they were justified in doing outrageous things because they were obligated to serve their stockholders.”  But the Court refused to lend this logic any credence: “[t]hat assertion is a perversion of the fiduciary regime.  Fiduciary duties exist to check management misbehavior.  They are not a license for management to misbehave.”

PRACTICAL TAKEAWAYS

          This decision highlights the extraordinary nature of specific performance as an equitable remedy and the potential factors and circumstances the Court will consider when deciding whether to award it.  Plaintiff acquirors seeking to compel their targets to close highly complex deals involving foreign parties and foreign assets face an uphill battle.

          But, perhaps more importantly, this decision serves as a warning to conflicted financial advisors, deal advocates, and fiduciaries alike, that the Court will not condone surreptitious, conflicted tactics masquerading as serving the shareholders.  The Court will look to the plaintiffs hands and apply the maxim: “he who seeks equity must do equity.”

Rolando Diaz of the Lewis Brisbois Delaware office prepared this post.

          The Court of Chancery refused to enforce a restrictive covenant in Sunder Energy, LLC v. Jackson, 2023 Del. Ch. LEXIS 580 (Del. Ch. Nov. 22, 2023). Chancery subsequently approved, with thorough reasoning, an interlocutory appeal to the Supreme Court–which makes its own determination whether to accept the interlocutory appeal.

BRIEF FACTUAL BACKGROUND

          Sunder Energy, LLC (“Sunder”), a Delaware LLC headquartered in the State of Utah, a purveyor of residential solar power systems, had an exclusive dealer agreement with Freedom Forever LLC (“Freedom”), one of the nation’s largest installers. In the summer of 2023, Freedom encouraged Tyler Jackson, the head of sales for Sunder, who lived and worked in the State of Texas, to join Solar Pros LLC (“Solar Pros”), another solar power system dealer that referred installations to Freedom.  This led to a mass exodus of Sunder’s workforce. Nine of the twelve regional managers that reported to Jackson, as well as over three hundred sales personnel, joined Solar Pros.  On September 25, 2023, Solar Pros announced that Jackson had joined as its new President.

          Sunder asserted that Jackson—as a holder of Incentive Units—was bound by certain restrictive covenants (the “Covenants”) provided for in Sunder’s 2019 and 2021 LLC operating agreements (the “OA”) that applied to any Incentive Unit holder (the “Holder”).  The co-founders formed Sunder by filing a certificate of formation with the Delaware Secretary of State but did not execute a written operating agreement. 

In the fall of 2019, the two co-founders that together owned 60% of the membership interest of Sunder engaged a law firm to draft an LLC agreement that dramatically changed the ownership structure of the LLC; it imposed the Covenants, emasculated the minority members rights as owners, and reduced them to purely economic beneficiaries with very little rights. Communications from the majority co-founders to the minority rights holders did not explain that the two co-founders received common units with full rights while the minority holders received incentive units with little to no ownership rights. 

In a concerted effort to obfuscate reality, the majority co-founders referred to the Holders as “partners,” implying that there was some semblance of equal footing aside from the difference in percentage of interests. For the subsequent adoption of the 2021 operating agreement, the majority co-founders did not even bother to circulate a copy of the new operating agreement.  Instead they only circulated the signature page and indicated to the Holders that there were no substantive changes to the operating agreement and that the only change was the addition of a member.  This was not true.  The geographical scope of the restrictive covenant was also expanded.

          In addition to broad restriction on the use of Sunder’s confidential information, the Covenants in the OA prohibited a Holder from: (i) engaging in any competitive activity (the “Non-Compete”); (ii) soliciting Sunder’s employees and independent contractors (the “Worker Non-Solicit”); (iii) soliciting, selling to, accepting any business from, or engaging in any business relationship with any of Sunder’s customers; and (iv) inducing, influencing, advising, or encouraging any Sunder stakeholder to terminate its relationship with Sunder. Furthermore, each Covenant bound not only the Holder, but also Holder’s affiliates, defined in the OA as a Holder’s spouse, parents, siblings, and descendants, both natural and adopted. The Covenants applied while a person held incentive units and for two years thereafter.  However, a Holder had no right to transfer or divest themselves of the Incentive Units. In contrast, Sunder had the option, but not the obligation, to repurchase the Incentive Units for zero dollars upon either Sunder’s termination of Holder’s employment or if the Holder left the company without good reason.

          On September 29, 2023, Sunder terminated the dealer-installation agreement with Freedom and filed an arbitration to enforce their rights against Freedom. Sunder also filed an action in the Court of Chancery against Jackson and its competitors. Sunder sought a preliminary injunction enjoining Jackson and any party acting in concert with Jackson from taking any action in breach of the Covenants. The Court denied the preliminary injunction because Sunder could not establish a reasonable likelihood of success on the merits.  The Court found (i) the restrictive covenants unenforceable under general principles of law and (ii) the competition and solicitation restrictive covenants unreasonable in their scope and effect.

KEY ANALYSIS

          First, the Court was faced with determining the Covenants’ governing law. The terms of the Covenants appeared in the OA, which governs the internal affairs of a Delaware LLC.  The OA expressly provided that Delaware law governed its terms.  Thus, a contractarian basis for the application of Delaware law existed. Under normal circumstances, the combination of the internal affairs doctrine and contract principles would require the application of Delaware law. However, for the Covenants, the drafters were not attempting to govern the internal affairs of a Delaware LLC.  Instead, the drafters were attempting to govern an employment relationship.  The Court opined:

Delaware follows the Restatement (Second) of Conflict of Laws, and Delaware courts consequently will not enforce choice of law provisions when doing so would circumvent the public policy of another state that has a greater interest in the subject matter. Consequently, when a different state’s law would govern in the absence of a choice of law provision, and if that state has established legal rules reflecting a different policy toward restrictive covenants, than Delaware’s then this court will defer to that state’s laws notwithstanding the presence of a Delaware choice of law provision.

Thus, either Utah, where Sunder is headquartered, or Texas, where Jackson worked and resided would apply in the absence of a choice of a law provision.  Under the Court’s analysis, both Texas and Utah approach the enforceability of restrictive covenants only slightly differently than Delaware. Under its conflict of laws analysis, due to the low degree of divergence between laws of the relevant forums, the Court applied Delaware law, finding that the conflict between Delaware and Utah law was a false conflict.

          Second, due to the circumstances for ratification of Sunder’s 2019 and 2021 LLC operating agreements, the Court determined that Sunder’s purported majority co-founders breached their fiduciary duty by failing to fully disclose all material information and making misleading partial disclosures to the minority.  The 2019 agreement materially and adversely impacted the rights of Sunder’s minority members; legal counsel only represented Sunder and the majority co-founders, but the co-founders made it seem as if counsel represented everyone. For the 2021 agreement, the co-founders told the minority members that the 2021 agreement contained no material changes and did not even bother to circulate a copy of the 2021 agreement to the minority members. Thus, the Court determined that due to the co-founders’ breach of fiduciary duties, the amended operating agreements themselves were invalid, and consequently, so were the restrictive covenants therein.

          Assuming, however, for the “sake of argument” that the amended LLC agreements were valid, the Court addressed the enforceability of two of the Covenants, namely, the Non-Compete and Worker Non-Solicit provisions. The Court found the Non-Compete provision extremely overbroad. The prohibited business activity covered a wide swath of the “door to door sales industry, without regard to whether Sunder markets or sells similar products.” The restriction on a Holder’s affiliates (as defined in the OA) was inane; it was not written in a manner that simply thwarts a straw man conferring the benefits to a Holder.  But, as written, a Holder’s “daughter cannot go door to door selling girl scout cookies.” Absurdly, the Covenants thus purported to bind a Holder’s wife and children. The geographic scope of the Non-Compete left only Alaska, Montana, North Dakota, and South Dakota available for a Holder as territory not restricted by the Covenants. Perhaps the most appalling factor of the Non-Compete was that since a Holder had no right to divest himself of the Incentive Units under the OA, the temporal component could continue in perpetuity. Similarly, the Court found the Worker Non-Solicit overbroad and unreasonable. It also applied to the same set of affiliates and for the same potentially “forever” time period. It extended not only to any current Sunder employee or independent contractor, but also applied to “any person employed in the past by Sunder for any period of time.” Individually, each overbroad provision was unreasonable.  And read together, the Court deemed the Covenants oppressive and refused to enforce them.

PRACTICAL TAKEAWAYS

          Delaware courts will not apply Delaware law under a theory of contract law if another state has a greater public policy interest in an issue when, absent a choice of law provision, another forum’s laws would apply. Circumstances may also dictate abandonment of the internal affairs doctrine when drafters embed employment provisions that have nothing to do with the governance of the entity into a governing agreement. Additionally, Delaware courts apply both general principles of law and a holistic analysis of restrictive covenants to determine reasonableness. This analysis can result in Delaware courts refusing to enforce restrictive covenants.

In a recent letter ruling, the Delaware Court of Chancery provided a short tutorial on the Chancery rules of procedure that describe the specific requirements for responding to discovery and the detail that the parties are obligated to provide, especially for objections. See Bocock, et al. v. Innovate Corp., et al., C.A. No. 2021-0224-PAF (Del. Ch. Dec. 6, 2023). 

For example, objections must be specific and must identify what is being withheld based on the objections. See Ct. Ch. R. 33(b)(4) (regarding interrogatories). See also Ct. Ch. R. 34 (regarding responses to requests for documents).

Highlights

  • Relying on prior Chancery decisions, the court instructed that “generic and formulaic objections are insufficient.” Slip op. at 8. 
  • The court also reminded us: that failure to assert a proper, timely objection in compliance with the rules risks waiver of objections. See Ct. Ch. R. 33(b)(4).
  • Specifically, the court referred to prior decisions that explain: “Boilerplate objections have been considered prima facie evidence of a Rule 26 violation, which causes the objecting party to waive any legitimate objections that they may or may not have had.”  Slip op. at 8-9.
  • The court instructed that “an objection must state whether the responding party is withholding or intends to withhold any responsive materials on the basis of that objection.”  Quoting Ct. Ch. R. 34(b).
  • The decision provides more examples of the failure to provide specificity or to explain the basis on which documents were being withheld. 
  • The court also emphasized why the failure to comply in this case justified waiver of all of the objections except for attorney/client privilege and work product doctrine.

Takeaway:

The Delaware Court of Chancery has emphasized the importance of specific, timely objections. Generic or formulaic objections are considered insufficient, potentially leading to waiver of objections. Failure to comply can result in waiving all objections.

Delaware Court of Chancery Rule 5.1 provides the standard and an intricate series of procedures for the parties to seek “confidential treatment” to prevent pleadings filed with the court from being publicly available. The prior version of the rule referred to this procedures as “filing under seal.”  Notably, analogous procedures in federal court employ a much different standard.

A recent pair of Orders from the Delaware Court of Chancery featured the unusual shifting of fees in connection with Rule 5.1, as an exception to the American Rule where each party pays its own fees. See Robert Garfield v. Getaround, Inc., C.A. No. 2023-0445-MTZ, Order (Del. Ch. Oct. 26, 2023). This is the first of two Orders that need to be read together to put them in context. The second Order is noted below.

The Orders understandably do not feature the typically copious background facts provided in opinions, but it includes sufficient information to make the point for purposes of this short blog post.

The noteworthiness of the Orders is that they will remind counsel that under Rule 5.1, when a party disagrees about what portions of a pleading should be designated as confidential, the party harboring the disagreement does not have the right to publicize the information sought to be kept confidential—until the court rules on the issue or unless the procedures provided in Rule 5.1 are followed.

With that background, the relatively short Order deserves to be quoted verbatim: 

“It was not for Plaintiff to unilaterally decide that information Defendant has designated and redacted as confidential in its opposition could be publicized in Plaintiff’s reply.  Defendant bore the burden of designation under Court of Chancery Rule 5.1(b)(3).  Nor was it for Plaintiff to resists Defendant’s call to withdraw Plaintiff’s Reply to publicize information Defendant had designated.  Rather, Plaintiff’s recourse was to file a Motion of Challenge to the Opposition and the Reply under Court of Chancery Rule 5.1(f).

The parties shall work with the Register in Chancery to place Plaintiff’s Reply under seal.  The parties shall follow Rule 5.1’s procedures to address any remaining disagreements as to whether information in that reply was fairly designated as confidential.”

The first Order was in response to a Motion by the Defendant to place under seal the Reply of the Plaintiff in opposition to the Defendant’s Motion to File Under Seal because that Reply was wrongly filed in a publicly available manner.

In a second Order shifting fees under the bad-faith exception to the American Rule, the Court reasoned that the Plaintiff’s:

“insistence on publicizing information Defendant designated as confidential serves no plain purpose other than agitation.  I conclude the publication in the opposition to the motion to seal was in bad faith. Fees are shifted for the Motion to Seal the Opposition.”

Garfield v. Getaround, Inc., C.A. No. 2023-0445-MTZ, Order (Del. Ch. Oct. 27, 2023)