Fully Executed Contract Ruled Unenforceable

A recent Delaware Court of Chancery opinion should be read by all lawyers who seek to avoid the risk of a fully executed contract being ruled unenforceable due to a court later finding, perhaps suprisingly, that the agreement did not accurately express the understanding of the parties.  In Kotler v. Shipman Associates, LLC, C.A. No. 2017-0457-JRC (Del. Ch. Aug. 21, 2019, corrected (typo on page four) Aug. 27, 2019), the court reviewed in extensive detail the multi-year history of negotiations and exchanges of draft agreements, with little contemporary evidence of the circumstances surrounding the fully-executed document–which one of the parties sought to enforce, and found the agreement, a warrant for stock, to be unenforceable.

In this short blog post, the most effective way to express the most important takeaways from this 47-page opinion (40-pages of which was a thorough recitation of the detailed facts), is to highlight what at least this reader considers the “lessons learned” from the misfortunes of the parties involved in this case, after a quick factual overview.Brief Factual Overview of Case:

This case involves a claim for equity in a cosmetics company that was formed in the founder’s kitchen in 1999. About 18 years later, the company was valued at about $500 million.  During the early years of the company, a commission-only sales consultant worked for the company and was, by all accounts, a very successful salesperson.  During the approximately 5 years that she worked at the company, she was promised a right to purchase equity in the company by means of a warrant.  Although the company continually promised her that it would formalize that right, they strung her along for many years without formalizing her right to equity.

During the lengthy negotiations and the exchange of many draft warrant agreements, one of the terms that the parties could not reach agreement on was the scope of a non-competition provision. Naturally, the company wanted to restrict any competition after the salesperson left the company, but the salesperson wanted the right to compete after she left.

The court, in its extensive review of the factual background, determined that notwithstanding a fully executed agreement, the former salesperson who was seeking to enforce the fully executed warrant agreement, was not credible and could not explain the absence of the non-competition provision that the company always insisted on as a deal-breaker in the negotiations. A key factual issue at trial was whether or not the sole signature page was attached to a version of the agreement that the company did not agree to–or whether the signature page was attached to a version of the warrant agreement that expressed the intent of all the parties.  The court held that despite the fully executed document, the signature page was attached to a version of the agreement that the overwhelming evidence indicated was not the version that expressed the intent of the company.

Key Takeaways:

·     Careful practitioners should consider the risk (in light of this case) inherent in allowing a client to sign an “orphan” signature-page as a separate page by itself–and then later attaching that page (only) to a document that the signature-page is not indubitably a part of. Rather, a lawyer should be able to prove that the signatory has read and agrees to all the terms of the agreement that the signature-page is attached to. That may seem obvious, but the contract at issue in this case was ruled to be unenforceable because the signature-page was formatted in such a way that it could be–and was–attached to a version of the contract other than the one that the signatory thought it belonged to. This risk also applies to the common practice of allowing “counterpart signatures” that may not be attached to the agreement at the time it is signed.

·     Kotler, the employee or independent contractor at the center of this case, was “strung along” by the company’s president, and repeatedly told that she would be given equity in the company, or a warrant for equity in the company, over many years, but formal documentation was never finalized in an enforceable agreement.  The lessons in that “not unusual” situation should be self-explanatory.

·     A fully executed agreement is not necessarily enforceable if there is overwhelming evidence to support the argument that notwithstanding one’s signature “attached to” an agreement, the signature was not intended to express consent for the terms of the contract that the signature was attached to.  See Slip op. at 44.

·     The Court explained that:

“[The] ‘fully executed’ version of the warrant agreement does not overcome the credible and convincing evidence that these parties were not operating from the same page, or more precisely the same agreement, as they negotiated its material terms.  The circumstances surrounding  the execution of the warrant agreement, cloudy as they are, reflect it is just as (if not more) likely Marissa [the CEO] believed she was signing a version with a perpetual non-compete as one with Kotler’s [consultant-employee] diluted covenants.  This is particularly so since Kotler could recall nothing of importance regarding the negotiations or circumstances surrounding the execution of the warrant agreement.  Incredibly, she could not even recall who she engaged as counsel to represent her during the negotiations, thereby cutting off a likely source of contemporaneous evidence.” 

Slip op. at 44.

·     The court also explained earlier drafts had a “deal-breaker” provision that the company always insisted on–but Kotler could not explain why the company would abruptly agree to waive that key term.  This severely undermined Kotler’s credibility.

·     In addition, the court reasoned that other contemporaneous and after-the-fact circumstantial evidence explained the “disconnect” between the long history of the parties’ positions during negotiations and the final document, such as the court’s following post-trial findings of fact: (i) counsel for the company prepared a subsequent draft that post-dated the version that Kotler sought to enforce; (ii) that later draft had a signature-page that the CEO signed and sent by itself–with no agreement attached; and (iii) that signature-page was likely attached to something other than the version that the company thought was the “final” version of the agreement that reflected its position.  Id. at 45.  See footnote 197 (citing Eagle Force Hldgs., LLC v. Campbell, 187 A.3d 1209, 1230 (Del. 2018) (allowing courts to resolve issues of fact by considering evidence of the parties’ prior or contemporaneous agreement and negotiations in evaluating whether the parties intended to be bound by an agreement)). See also footnote 200 (citing to case law indicating that the actions of the parties after the deal are informative regarding their intent). 

·     Reciting basic contract formation principles, the court ultimately found that despite the agreement being fully executed, the terms of the agreement did not express the consent of the parties to material terms, and that a contract cannot be enforceable if the parties did not manifest an intent to be bound to essential terms as “determined objectively based upon their expressed words and deeds as manifested at the time, rather than by their after-the-fact professed subjective intent.”  Slip op. at 42-43.  (Although the court refers to the absence of a “meeting of the minds,” the standard for contract interpretation is an objective one.)

·     In sum, this opinion should be read as a cautionary tale that underscores the risk for any lawyer or client who prefers to sign a signature-page separately–instead of keeping the signature-page and the corresponding agreement “together” at all times.

Director Denied Attorney/Client Communications–Firm Did Not Represent Whole Board

A recent Delaware Court of Chancery decision explained that: the general rule that a director is entitled to communications with counsel for the board has exceptions, but the threshold issue is whether the attorney involved represents the whole board–or just selected board members.  In Gilmore v. Turvo, Inc., C.A. No. 2019-0472-JRS (Del. Ch. Aug. 19, 2019), the court restated the general rule that a Delaware corporation “cannot assert the privilege to deny a director access to legal advice furnished to the board during the director’s tenure.”  See footnote 19.  The court acknowledged that there are three exceptions to that general rule, but an important condition to the general rule is that the legal advice be furnished to the whole board.  See Slip op. at 7.

In this case, a law firm was hired to conduct an internal investigation only by certain stockholders and only the representative(s) of those stockholders on the board–but the court determined that the firm conducting that internal investigation did not represent the board as a whole, and therefore, the board member who filed a motion to compel in this case was not entitled to attorney/client communications with that firm because the firm was not representing the whole board at the relevant time during which the communications were sought. 

The court also reasoned that the director did not have a reasonable expectation that the attorneys in question were representing all members of the board.  Therefore, the court denied the motion to compel those communications. 

This opinion should be contrasted with the many cases highlighted on these pages that discuss the general rule that a board member usually enjoys “unfettered access” to corporate documents, with exceptions.  See, e.g., Chancery decision in Papa John’s case highlighted on these pages.

Special Litigation Committee Allows Derivative Litigation

A recent Delaware Court of Chancery decision involved the unusual situation where a Special Litigation Committee allowed derivative plaintiffs to pursue claims challenging an acquisition of the defendant company.  See In re Oracle Corp. Derivative Litigation, C.A. No. 2017-0337-SG, Letter (Del. Ch. Aug. 15, 2019).  Another unusual case in which a Special Litigation Committee did not oppose the pursuit of derivative claims was in the matter of American International Group, Inc. Consolidated Derivative Litigation, C.A. No. 769-VCS (consol.) opinion; (Del. Ch. Feb. 10, 2019).  [This second citation comes to us courtesy of The Chancery Daily (publication of Aug. 22, 2019).]

TRO Granted to Enforce Covenant-Not-To-Compete Despite Liquidated Damages Provision

The Delaware Court of Chancery granted a TRO recently to enforce a covenant-not-to-compete, or non-compete agreement, notwithstanding a liquidated damages provision and the (unsuccessful) argument that such a provision created the absence of irreparable harm needed for injunctive relief. In Affinity Wealth Management LLC v. McPoyle, C.A. No. 2019-0441-JTL, transcript (Del. Ch. June 18, 2019), the court followed well-established Delaware law which generally enforces covenants-not-to-compete that are reasonable in duration and in geographic scope.

Key Aspects of Ruling:

The court rejected the argument that the irreparable harm necessary for granting injunctive relief was not present due to the presence of a liquidated damages clause that calculated the monetary loss from the clients whom the former employee was alleged to have taken.

The court explained that the non-competition agreement at issue included recognition by the parties that in addition to monetary damages, equitable remedies would be available in light of the inability of damages to address all forms of harm, including reputational damages and loss of goodwill.

Money Quote:

In particular, the court explained that:

. . . the actual harm from individual clients [leaving] isn’t the only type of harm that a business can suffer. It can suffer loss of goodwill–and goodwill broadly takes in all kinds of factors, including reputation in the market place, future earning power, ability to attract new clients, etcetera.  So it’s not only the loss of existing clients that’s problematic, which the Liquidated Damages clause seems to go some way to addressing, but also the other factors.

Postscript:

Some period after the TRO was entered, in response to a follow-up motion, the court clarified the scope of its TRO in light of apparent efforts of the ex-employee continuing to contact clients post-TRO, and the Court explained that the TRO should be read to prohibit the ex-employee from reaching out to contact clients of the former employer, and rejected a request to narrowly define the word solicit, used in the TRO.

N.B. Yours truly represented Affinity Wealth Management LLC in this matter.

I’m a Contributing Author for: “The Art of M&A: A Merger, Acquisition and Buyout Guide” (5th ed. 2019)

Your truly is a contributing author for a recently published treatise entitled: “The Art of M&A: A Merger, Acquisition and Buyout Guide” (5th ed. 2019), edited by Alexandra Reed Lajoux. I was asked to attend a book signing at the flagship Barnes & Noble store on 5th Avenue in New York City on August 22, 2019, at noon, in connection with the announcement of the publication of the book. Details available at this link.

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Confidentiality Agreement Not Always Required for Section 220 Demands

The Delaware Supreme Court recently announced a decision of great importance for stockholder demands under Section 220 of the Delaware General Corporation Law. In Tiger v. Boast Apparel, Inc., No. 23, 2019 (Del. Supr. Aug. 7, 2019), the Delaware Supreme Court ruled that:

(i) although inspection of records demanded by stockholders pursuant to Section 220 is typically conditioned on a confidentiality order, or stipulation or agreement, such inspections are “not subject to a presumption of confidentiality”;

(ii) when the court, in the exercise of its discretion, enters a confidentiality order, an indefinite period of confidentiality protection should be the exception and not the rule; and

(iii) a party demanding books and records need not show exigent circumstances for a court to grant something less than indefinite confidentiality, under Section 220.

Regular readers familiar with the voluminous highlights on these pages of Section 220 cases over the last 14 years, are aware that despite the relative simplicity of the statute, pursuing rights under Section 220 requires stamina and patience and financial wherewithal.

Procedural Background:

This case involved an initial demand in December 2014 for books and records pursuant to Section 220. The primary dispute related to the scope and duration of a confidentiality agreement that the company required.  A second demand under Section 220 was sent in February of 2017, and again the parties could not reach an agreement over the terms of a confidentiality agreement.  In October 2017, a complaint was filed in the Court of Chancery demanding access to books and records based on a demand amended in May 2017.  The primary dispute between the parties continued to be the scope of the confidentiality obligations imposed by the company on its production.  Although the stockholder also requested non-confidential records, the company demurred.

A Master in Chancery submitted a report in July 2018 recommending indefinite confidentiality until such time as the stockholder filed a suit based on the inspection, after which confidentiality would be controlled by the applicable court rules. This appeal followed the finality of the Master’s Report.

Highlights of Court’s Ruling:

  • Although the court disagreed with the reasoning of the Court of Chancery, it affirmed the decision because even though the Supreme Court would have employed different reasoning, there was no abuse of discretion or reversible error with the result.
  • The Supreme Court clarified that there is no presumption of confidentiality in productions of data pursuant to Section 220.
  • Although a corporation need not show specific harm that would result from disclosure before receiving confidentiality treatment in a Section 220 case, Delaware’s High Court explained that: “One cannot conclude reflexively that the need for confidentiality is readily apparent.”
  • The Court ruled that: (i) An indefinite period of confidentiality protection should be the exception and not the rule; (ii) A party demanding Section 220 books and records need show exigent circumstances for a court to grant something less than an indefinite confidentiality.
  • Although the Supreme Court disagreed with Chancery’s grant of indefinite confidentiality restrictions until a suit was filed, the stockholder did not make an adequate showing of reversible error.

In sum, this decision can be added to the extensive list of examples of Section 220 cases that have been lengthy and expensive for the stockholder to pursue to a final adjudication in the court of last resort in Delaware. Although the Delaware case law is well-established that stockholders should employ Section 220 before filing a plenary complaint, that effort–in the end–is not always satisfying.

Earn-Out Dispute: Ambiguous Terms Bar Motion to Dismiss

The recent Delaware Court of Chancery decision in Windy City Investments Holdings, LLC v. Teachers’ Insurance and Annuity Association of America, C.A. No. 2018-0519-MTZ (Del. Ch. July 26, 2019), discussed an often recurring issue in commercial litigation: a seller of a business who claims that the Earn-Out provisions in the agreement of sale were not complied with by the buyer.

Key Takeaways:

The most noteworthy aspects of this decision are the thorough recitation of important contract interpretation principles, and a similarly thorough application of those principles. The key statements of law are found on pages 14 and 17.  The court’s reasoning is found most prominently at pages 15 and 22.

·     For example, the court explained that in the context of a motion to dismiss, the moving party in a contract dispute must demonstrate that its interpretation is the only reasonable reading of the disputed provision.

·     However, when the court “may reasonably ascribe multiple and different interpretations to a contract, it will find that the contract is ambiguous.  To be ambiguous, a disputed contract term must be reasonably susceptible to more than one meaning.”  See footnotes 36 and 37 and accompanying text.

·     In this case, the court found that each party’s contract construction left “something to be desired,” and would require the court to “import extra-contractual concepts to reconcile” the language in the agreement.

·     The court observed that an unreasonable interpretation of an agreement “produces an absurd result or one that no reasonable person would have accepted when entering the contract.”  See footnote 46 and related text.

·     The court reasoned that no party offered the only reasonable construction, and because the contract was susceptible to two or more reasonable interpretations and two of more meanings, the contract was ambiguous and required extrinsic evidence to determine the contractual intent of the parties–thus being inappropriate for decision at the motion to dismiss stage.  See footnote 58 and accompanying text.

Court of Chancery Addresses Personal Jurisdiction Over De Facto LLC Manager

The Delaware Court of Chancery addressed in a recent opinion the nuances of imposing personal jurisdiction (in a second ruling on the issue in as many days), in connection with someone who served as a de facto manager of an LLC.  In Metro Storage International LLC v. Harron, C.A. No. 2018-0937-JTL (Del. Ch. July 19, 2019), the court provided what can be fairly described as a definitive and comprehensive analysis, in the nature of a treatise, on the topic of the implied consent to personal jurisdiction over a person who serves as a formal, or de facto, manager of an LLC, based on § 18-109(a) of the Delaware LLC Act.  This decision is a “must read” for anyone who needs to understand the nuances of Delaware law on this topic.

In addition, the court provides a thorough discussion of the requirements, in general, for imposing personal jurisdiction over a non-resident. This should be compared with the decision issued a day earlier, by the same member of the Court of Chancery, which also discussed the requirements of imposing personal jurisdiction, in the matter styled: Clark v. Davenport, C.A. No. 2017-0839-JTL (Del. Ch. July 18, 2019), highlighted on these pages here.

Key Takeaways:

This matter involved fraud claims against an LLC manager. The court recited many important aspects of Delaware corporate and commercial litigation, including the following important points:

  • This opinion engages in a “deep dive” that includes a review of all the prior Delaware case law that addresses the issue of implied consent to personal jurisdiction over a person who serves as a formal or de facto manager of an LLC, based on § 18-109(a) of the Delaware LLC Act. This thorough analysis is must reading for anyone who needs to understand this topic and wants to review the most complete analysis of the applicable case law in one place. See pages 8-39.
  • The court explains generally that based on the Delaware LLC Act, by default, an LLC is a member-managed entity unless the LLC Agreement provides otherwise. See page 39, citing § 18-402 of the Delaware LLC Act.

Personal Jurisdiction:

  • The basic concepts of personal jurisdiction are explained in the context of the Delaware Long-Arm Statute, 10 Del. C. § 3104(c)(1).
  • The court explains that “agency status” expands jurisdiction, and does not limit it under the plain language of the Delaware Long-Arm Statute.
  • Moreover, the court explored the concept of the common-law agency theory of jurisdiction, which provides a basis for asserting jurisdiction over a non-resident principal by attributing the jurisdictional acts of the agent to the principal. When this theory applies, it does not shield the agent from jurisdiction–nor does it substitute the principal for the agent; it instead enables the plaintiff to add the principal to the case in addition to the agent.” See pages 50-51. See generally Donald J. Wolfe, Jr. & Michael A. Pittinger, Corporate and Commercial Practice in the Delaware Court of Chancery, § 3.04[c][3] (2d ed. & Supp. 2018).
  • The court explained that an actor’s status as an agent provides an avenue to hold the principal liable in addition to the agent under principles of attribution. See Verrastro v. Bayhospitalists, LLC,—A.3d—, 2019 WL 1510458, at * 2 (Del. Apr. 8, 2019) (discussing respondeat superior).

Due Process:

  • The court explained that in connection with analyzing whether there are sufficient minimum contacts with Delaware to require a non-resident to defend itself in the courts of this State, the court considers the following relevant factors: (i) the forum state’s interest in adjudicating the dispute; (ii) the interest of the plaintiff in obtaining convenient and effective relief; and (iii) the interstate judicial system’s interest in obtaining the most efficient resolution of controversies. See page 53 (citing Istituto Bancario Italiano SpA v. Hunter Eng’g Co., 449 A.2d 210, 225 (Del. 1982)) (citations omitted).
  • The court in this matter also observed that because the non-resident traveled frequently around the country, and in other countries, that by comparison litigating in Delaware would be a “relatively inconsequential burden that Delaware’s interest far outweighs.” See page 55.
  • The court also considered, in addition to the above factors, that: the citizens of Delaware have an interest in using its courts to recover for the injuries they claim to have suffered. See page 55.

Chancery Addresses Personal Jurisdiction Over Co-Conspirator

A recent Delaware Court of Chancery decision provides an excellent analysis of the requirements for imposing personal jurisdiction based on the Delaware Long Arm Statute, and also addresses the fiduciary duty of disclosure in a thorough manner worthy of careful reading.  In Clark v. Davenport, C.A. No. 2017-0839-JTL (Del. Ch. July 18, 2019), the court provided a noteworthy explanation of the important nuances that need to be understood when personal jurisdiction is contested.  This is the second opinion in two days by the same member of the Court of Chancery that addressed personal jurisdiction in the context of a motion to dismiss under Del. Ct. Ch. Rule 12(b)(2).

The factual context of this case is based on claims against those who assisted in the fraudulent inducement of the plaintiff to invest in a troubled company that was presented as being much more prosperous than it was.

Key Takeaways:

Although the factual details are important to a complete understanding of the court’s analysis, and there are important statements of Delaware corporate law in this opinion, I will mostly focus on the aspects of the opinion that address the personal jurisdiction analysis, in the format of bullet points, while first mentioning a few other key pronouncements of practical value to those of us who toil in the vineyards of corporate and commercial litigation:

  • The court describes the nuances of the fiduciary duty of disclosure to buyers of stock, especially as it compares to the fiduciary duty of disclosure when, for example, directors are communicating with stockholders and seeking stockholder action. See pages 17 through 20.
  • The court explains that in order to be effective an anti-reliance clause must be explicit, and should not be conflated with a different clause, known as a “pro-sandbagging” clause. See page 22.
  • The court explains the important difference between fraud and puffery at pages 23 through 27.
  • The court explains the elements of a claim for aiding and abetting fraud at page 33.

Personal Jurisdiction Analysis:

The analysis in this case of personal jurisdiction should be compared with an equally helpful personal jurisdiction analysis in an opinion issued by the same author one day later in the matter styled Metro Storage International LLC v. Harron, C.A. No. 2018-0937-JTL (Del. Ch. July 19, 2019), highlighted on these pages here.

  • In the context of a motion to dismiss based on an alleged lack of personal jurisdiction, a motion is filed under Rule 12(b)(2), and the court applies a two-part test: First, the court must determine whether the Delaware Long-Arm Statute at 10 Del. C. § 3104(c) is applicable. If so, the court must decide whether subjecting a non-resident defendant to jurisdiction would violate due process. That is, the non-resident defendant must have sufficient minimum contacts with a forum state such that the maintenance of the suit does not offend traditional notions of fair play and substantial justice (citing Matthew v. Flakt Woods Gp. SA, 56 A.3d 1023, 1027 (Del. Ch. 2012). See generally Donald J. Wolfe, Jr. & Michael A. Pittenger, Corporate and Commercial Practice in the Delaware Court of Chancery, § 3.02 (2d ed. & Supp. 2018).
  • The Delaware Long-Arm Statute provides that a court may exercise personal jurisdiction over a non-resident, or a personal representative, who in person or through an agent: transacts any business or performs any character of work or service in the state. 10 Del. C. § 3104(c)(1).
  • Jurisdiction under the statute can be based on a single transaction where the claim is based on that transaction. See pages 38 to 39.
  • Importantly, the court underscored that the Delaware Long-Arm Statute allows that: “forum-directed activity can occur “through an agent.” 10 Del. C. § 3104(c).

Due Process and Conspiracy Theory of Personal Jurisdiction

  • For purposes of due process, the question is whether the defendant had sufficient minimum contacts with Delaware such that compelling it to defend in the state would be consistent with the traditional notions of fair play and substantial justice. See page 9.
  • The court also discussed the five elements of the conspiracy theory of personal jurisdiction. See pages 39-40.
  • The conspiracy theory of jurisdiction was first announced by the Delaware Supreme Court in the case of Istituto Bancario Italiano SpA v. Hunter Eng’g Co., 449 A.2d 210, 225 (Del. 1982).
  • The court explained that the elements for the conspiracy theory of jurisdiction satisfy both prongs of the jurisdictional test. The first three elements encompass the statutory prong regarding the requirements of the Delaware Long-Arm Statute. The third element corresponds to the statutory requirement that the defendant had transacted business or performed work in the state. The fourth and fifth elements speak to due process and whether the minimum contacts are such that the defendant should have reasonably anticipated being sued in the forum.
  • The court noted in closing that the question of whether a defendant was validly served should be raised in a motion to dismiss under Rule 12(b)(5), and not under Rule 12(b)(2).

Extrinsic Evidence Required When Contractual Intent Unclear

A recent Delaware Court of Chancery case should win a “candor award” for acknowledging that despite the arguments of both sides regarding the alleged intent of parties in the agreement at issue, the court found that notwithstanding multiple re-readings of both the agreement involved, and the arguments of the parties in their briefs, the court could not quite understand the intent of the parties to the contract. Therefore, the court determined that extrinsic evidence was required to determine the intent of the parties (and to understand the meaning of the agreement). Thus, the motions to dismiss were denied. See Western Standard LLC v. Sourcehov Holdings, Inc., C.A. No. 2018-0280-JRS (Del. Ch. July 24, 2019).

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