Chancery Addresses Liquidated Damages Clause in Non-Competition Agreement

The following synopsis was prepared by Chauna Abner, an attorney in the Delaware office of Eckert Seamans.

In Lyons Ins. Agency, Inc. v. Kelly Wark, et al., C.A. No. 2017-0348-SG (Del. Ch., Jan. 28, 2020), the Court of Chancery opined on the enforceability of a liquidated damages provisions in a non-competition agreement. The Court explained that liquidated damages provisions in non-compete agreements will be enforced if the liquidated damages “reasonably relate to an actual anticipated loss caused by the employee’s anti-contractual competition.” Id. at *1. On the other hand, the Court noted that it will not enforce a liquidated damages provision “that is simply a contractual penalty untethered to losses caused by ex-employee competition.” Id.

Brief Overview of Case

In this Lyons decision, the plaintiff hired the defendant as an insurance agent. The employment agreement the defendant signed provided for liquidated damages in the event the defendant began working for a competitor and a Lyons client decided to take its business to the competitor. Eventually, the defendant began working for a competitor, and later, without any encouragement or participation by the defendant, a Lyons client fired Lyons and took its business to the competitor.

Court’s Analysis

The Court held that although the non-compete provision of the employment agreement was presumptively valid, as a matter of public policy, the liquidated damages provision was not. Id. at *2. The Court primarily based its holding on the fact that the liquidated damages provision was “untethered to any competitive act by the former employee.” Id.

The Court ruled that “[a]s a general rule, a liquidated damages provision must represent a reasonable estimate of the monetary loss likely to be suffered, yet relate to an injury incapable of accurate estimation to be valid.” Id. at *6. The Court found that the liquidated damages provision of the employment agreement worked as a penalty unrelated to any contractual breach by the defendant and therefore did not meet this requirement. Id.

Key Takeaway

A court may enforce a liquidated damages clause in a non-compete agreement, but the clause must adequately connect the estimated loss the employer will suffer to the conduct of the employee.

Chancery Addresses Usurpation of Corporate Opportunity

The following synopsis was prepared by Chauna Abner, an attorney in the Delaware office of Eckert Seamans.

In Leased Access Preservation Association v. Ivan Thomas, et al., C.A. No. 2019-0310-KSJM, Order (Del. Ch. Jan. 8, 2020), a non-profit, non-stock corporation filed suit against Ivan Thomas, a former board member of the plaintiff, alleging, in part, that Thomas breached his fiduciary duties of loyalty and good faith by: (1) misappropriating or usurping a corporate opportunity for his own benefit and to the detriment of the plaintiff; and (2) using confidential information Thomas obtained as a director of the plaintiff to compete against the plaintiff in a bid for a contract.

Brief Overview of Case

More specifically, the complaint alleged that from 2014 through March 2019, the plaintiff leased Channel 28 from the City of Wilmington. The complaint also alleges that from December 2017 through January 2019, Thomas served on the plaintiff’s board of directors. In November 2018, the City of Wilmington began soliciting proposals for the management of Channel 28. The complaint alleges that Plaintiff submitted its bid to manage the channel — and Thomas, while still on the Board, submitted a competing bid on behalf of his media company. Thomas and the plaintiff were the only two bidders. The City of Wilmington awarded the contract to Thomas’s company.

Elements of Claim

In deciding whether to dismiss the complaint, first the Court explained the well-known elements a plaintiff must prove to establish a claim for misappropriating or usurping a corporate opportunity:

(1) the corporation is financially able to exploit the opportunity; (2) the opportunity is within the corporation’s line of business; (3) the corporation has an interest or expectancy in the opportunity; and (4) by taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimical to his duties to the corporation.

Id. at 6 (quoting Broz v. Cellular Info. Sys., Inc., 673 A.2d 148, 155 (Del. 1996)).

Court’s Reasoning

The Court distinguished the facts of this case from the facts of Triton Constr. Co. v. Eastern Shore Elec. Serv., Inc., 2009 WL 1387115 (Del. Ch. May 18, 2009), where a defendant employee who worked simultaneously for a competing business submitted several bids for the competing business at the same time the plaintiff submitted bids. In that case, the court held that the plaintiff’s own submissions of bids on those projects precluded it from claiming that the former employee usurped or diverted those projects under the corporate opportunity doctrine since it was arguable whether any one contractor would have had a reasonable expectation that its bid would be accepted on any one job.

The Court resolved all facts in favor of the plaintiff, as required in the procedural context of a motion to dismiss under Rule 12(b)(6), and ultimately held that “[g]iven the nature of this market and the limited pool of bidders, it is reasonably conceivable that LAPA had a reasonable expectation in obtaining the Channel 28 contract.” The Court further held that had Thomas not interfered, there was a reasonable probability that the plaintiff would have been awarded the contract as the only remaining bidder.

Failure to Allocate Estimated Damages to Each Claim Proves Costly

A recent Delaware Court of Chancery decision is notable for its explanation of the basic law of damages for contract and fraud claims, as well as cautioning that a damage expert’s estimate of damages needs to correspond to each of the counts in the complaint.

In Great Hill Equity Partners IV, LP, v. SIG Growth Equity Fund I, LLLP, C.A. No. 7906-VCG (Del. Ch. Feb. 27, 2020), the court discussed the damages aspect of this bifurcated case in which liability was determined in a prior post-trial memorandum opinion now known as Great Hill I. See Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, 2018 WL 6311829 (Del. Ch. Dec. 3, 2018). That decision was highighted on these pages, as were several other prior rulings over the last few years in this long-running matter.

Brief Overview:

This case involved claims by the buyer of a company that the seller engaged in fraud and breach of contract regarding the sale.

Great Hill I found liability for only a few of the many claims in the complaint. The current decision noted that the damage expert prepared a report prior to the trial–but did not update it after the court’s ruling on liability and prior to the oral argument for the ruling on damages. See pages 44-45 and footnote 227.

The plaintiffs sought over $100 million in damages but were awarded less than $500 thousand in damages.

Highlights of Key Principles:

  • One of the lessons to be learned from this 65-page opinion is that a damage expert needs to allocate damages to correspond to each claim in the complaint–or acknowledge which counts have overlapping damages. See pages 55 to 56.
  • The court provides a useful recitation of the law of damages in Delaware for fraud and contract claims. See page 49–50; and footnote 239.
  • The law in Delaware is that the estimate of damages need not be proven with mathematical certainty as long as the court has a basis to determine a responsible estimate. See pages 53 to 55.
  • Notably, damages cannot be based on speculation, however. See footnotes 254-258, and accompanying text.
  • The quantum of proof needed to show that damages exist, is higher than the proof needed to establish the amount of damages.

Chancery Determines Standard Applicable to Contested Transaction

The recent Delaware Court of Chancery decision in Salladay v. Lev, No. 2019-0048-SG (Del. Ch. Feb. 27, 2020), addressed the standards the Court may apply to review the conduct of directors in a contested transaction, and determined that the entire fairness standard applied, based on the facts of this case, resulting in a denial of a motion to dismiss.

Key Points:

This decision is must reading for those who want to be familiar with the latest iteration of Delaware law regarding the analyses the court employs to review a challenged transaction to determine whether fiduciary duties were fulfilled.

In this case, the court determined that the business judgment rule did not apply. The court provides a practical, educational elucidation of why the efforts to “cleanse” the transaction did not revive the business judgment rule, in light of the failure to satisfy the prerequisites discussed in Corwin v. KKR Holdings, LLC, 125 A.3d 304 (Del. 2015); Kahn v. M & F Worldwide (MFW), 88 A.3d 635 (Del. 2014); and In re Trados, Inc. Shareholders Litigation (Trados II) 73 A.3d 17 (Del. Ch. 2013).

The court also discusses the recent Delaware Supreme Court cases which clarified “where or when the line is drawn” for  the “cleansing” criteria to be considered as being imposed “ab initio,” such that a deal will earn the deferential BJR review standard, in Flood v. Synutra International, Inc., 195 A.3d 754 (Del. 2018), as well as Olenik v. Lodzinski, 208 A.3d 704 (Del. 2019).

Anthology of Blurbs About Recent Delaware Corporate and Commercial Decisions

In a departure from the manner in which most cases have been highlighted on these pages, this post includes a collection of short blurbs about recent Delaware corporate and commercial decisions, identifying the key issues addressed, with a link to the whole opinion. This experimental approach to highlighting recent decisions was prompted by a combination of many decisions published recently and an increased workload from paying clients.

Supreme Court Interprets Bylaws and Enforceability of Contractual Deadlines

A recent decision of the Delaware Supreme Court should be read by anyone who needs to know the latest iteration of Delaware law on the following issues:

  1. Interpreting bylaws;
  2. Prerequisites for the nominations of directors; and,
  3. Enforceability of contractual deadlines to provide replies or information.

See Blackrock Credit Allocation Income Trust v. Saba Capital Master Funds, Ltd., Del. Supr., No. 297, 2019 (Jan. 13, 2020). Of course, a careful reading of the entire 32-page decision is warranted, but for purposes of this short blog post I merely highlight the key issues addressed for those who find the topics to be of interest.

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Chancery Explains Doctrine of Recoupment

A recent Delaware Court of Chancery decision addressed the nuances of the doctrine of recoupment, as well as the timetable/deadline by which counterclaims with such defenses must be asserted. See Claros Diagnostics, Inc. v. Opko Health, Inc., C.A. No. 2019-0262-SG (Del. Ch. Feb. 19, 2020). The entire 36-page decision should be reviewed carefully for those who need to understand the nuances of this less-than-common legal topic.

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Court Analyzes Stock Sale Under Entire Fairness

A recent decision of the Delaware Court of Chancery analyzed a stock sale that took place after suit was filed. The sale was intended to make moot a suit under DGCL Section 226 seeking to appoint a custodian based on a deadlock. In connection with that analysis, the court discussed the different levels of review applicable to such actions, in addition to the business judgment rule, based on which a court will analyze the actions of directors or others who owe fiduciary duties. See Coster v. UIP Companies, Inc., Cons., No. 2018-0440-KSJM (Del. Ch. Jan. 28, 2020).

The court also includes an instructive discussion of the nuanced analysis to determine whether or not a director should be deemed independent and/or disinterested. For example, the court cites to case law indicating that financial considerations are not the only basis to determine whether or not a director is interested. This is so, because the Court observed that: human relations and motivations are complex and

“greed is not the only human emotion that can pull one from the path of propriety; so might hatred, lust, envy, revenge, or, as is here alleged, shame or pride.”

See footnotes 219 and 220, and accompanying text. That eminently quotable above passage deserves to be memorized.

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Chancery Considers Alleged Fraudulent Transfers in a Failing Company

The Court of Chancery recently analyzed whether or not certain transfers should be treated as fraudulent conveyances, but the court concluded that the complaint was time-barred to the extent that it challenged dividends that were declared and paid beyond the allowable time period to file a claim. See Burkhart v. Genworth Financial, Inc., No. 2018-0691-JRS (Del. Ch. Jan. 31, 2020).

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Chancery Addresses Squeeze-out of Founder

For those interested in a thoughtful and careful analysis of a matter involving the squeeze-out of a founder, and claims related thereto, see Ogus v. Sporttechie, Inc., No. 2018-0869-AGB (Del. Ch. Jan. 31, 2020).

 

Chancery finds failure to allege conspiracy means dismissal of ex-director and his foreign firms

This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.

The Delaware Court of Chancery recently dismissed the remaining defendants from a lawsuit that Wanu Water Inc.’s founder filed against directors and shareholders who allegedly conspired to seize control, finding a boardroom rival’s opposition to his management decisions did not constitute disloyalty or a civil conspiracy in O’Gara, et al. v. Coleman, et al., No. 2018-0708-KSJM, memorandum opinion (Del. Ch. Feb. 14, 2020).

In her Feb. 14 opinion, Vice Chancellor Kathaleen St. J. McCormick granted the dismissal motion filed by ex-Wanu director Sheldon Coleman and two foreign companies through which he held stock in the Delaware-chartered nutrient-infused water bottler based in California.

Not “reasonably conceivable”

The complaint fails to plead facts making it “reasonably conceivable” that Wanu President and controlling shareholder Todd O’Gara could show Coleman breached his fiduciary duty, damaged company’s business or libeled O’Gara in a failed 2018 ouster attempt, the Vice Chancellor said.

And since he failed to plead the existence of a civil conspiracy to benefit Coleman and his allies to the detriment of the public Wanu shareholders, O’Gara may not rely on the conspiracy theory to establish jurisdiction over Coleman’s non-Delaware defendant business entities, she said.

O’Gara founded Wanu in 2010 and stepped down from his CEO position in 2014 while remaining its President, Chairman-of-the Board and, through 2017 voting agreements, the controlling shareholder.

Lawsuits that O’Gara filed in Delaware, Texas and North Carolina sprang from the directors’ March 2018 removal of his successor CEO, Steve Dollase, who, one month later, supported by two shareholders, blamed O’Gara for inhibiting his job performance.

According to the vice chancellor’s opinion, when Dollase claimed he had discovered evidence of O’Gara’s several hundred thousand unauthorized stock shares and excessive spending, the directors authorized an independent counsel investigation in May.

A confidential July report to the board found that Dollase’s allegations were partly motivated by his dislike of O’Gara’s management style and personality, and that Dollase was generally not well-liked as a leader, whose management style created office tension.

The following month, another set of allegations by the Dollase faction — questioning O’Gara’s education and qualifications — resulted in a second independent investigation and report that was unable to confirm some of O’Gara’s degrees.

Need to investigate revenue sources

Meanwhile, Wanu was in “dire need of cash,” by August 2018, but while Coleman and other directors proposed an issue of convertible notes at a $0.40 per-share price, O’Gara opposed it, claiming it radically undervalued the company and provided Coleman with discount-priced stock that would dilute his controlling share, the court said.

In addition, Coleman and three allies on the board demanded that O’Gara drop numerous potential claims against Wanu and disclose alleged misrepresentations he had made concerning his education; but O’Gara refused and the financing was not approved.

In late August 2018, the boardroom battle culminated with the Coleman faction’s call for O’Gara to “step aside from all operations at Wanu, relinquish his seat on the board and agree to waive his right to elect five of the seven members of the board.”

O’Gara refused, and, when he learned of a special directors meeting scheduled of August 27, “regarding corporate governance,” he took the preemptive step of removing and replacing Coleman, Sergio Pedreiro and Linn Evans on the board by written consent.

Coleman, through his Green Lantern L.P. and Green Lantern Ventures LLC entities, allegedly continued his campaign as a stockholder, allied with investor activists Jay Brinkley and Greg Hunter, writing letters to shareholders calling out O’Gara’s “potential alleged misuse of shareholder capital,” and asking them to seek his ouster.

That prompted O’Gara’s September 28, 2018 Chancery Court complaint that at one point, included four opposing directors, but in April 2019, he stipulated to dismiss directors Pedreiro, Evans and Adrian Leuenberger and his Swiss company, Lion Consulting Gmbh.

In response to Coleman and his Green Lantern entities’ motion to dismiss for failure to state a claim and lack of personal jurisdiction respectively, the vice chancellor found no “reasonably conceivable” set of circumstances that would allow O’Gara to recover.

No conspiracy or jurisdiction

She found no support for O’Gara’s claim that Coleman or Green Lantern “engaged in a conspiracy with the other directors, Hunter and Brinkley or Dollase” because he failed to plead facts supporting:

  • The existence of a confederation or combination of two or more people,
  • Commission of an unlawful act in furtherance of a conspiracy and
  • Actual damage caused to the company

Criticism of O’Gara and demands for him to step aside do not qualify as a conspiracy, especially when they are couched as concerns for the company’s fiscal future, Vice Chancellor McCormick wrote.

She dismissed the complaint, finding it failed to state a claim for:

  • Breach of fiduciary duty — because it lacked proof that Coleman acted disloyally or harbored self-interest adverse to Wanu’s best interests.
  • Tortious interference — because there was no business opportunity, contract or agreement for him to interfere with and no specific damages alleged.
  • Libel — because O’Gara became a “limited purpose public figure” by taking a corporate office and entering into a public controversy, so he must prove the statements about him were false and were made with actual malice, and he fails to plead both adequately.
  • Jurisdiction over non-Delaware defendants — because “under the conspiracy theory of jurisdiction, a plaintiff must plead facts demonstrating the existence of a conspiracy” and since O’Gara fails to do this regarding Coleman or Green Lantern there is no basis for jurisdiction or even jurisdictional discovery.

 

Chancery: Tesla investors need only prove Musk had coercive influence ability in SolarCity deal

This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.

The Delaware Court of Chancery recently found that a trial is needed to decide whether, despite his minority share of Tesla Motors Inc., CEO Elon Musk could exert a controller’s “coercive influence” over the electric carmaker’s shareholders who approved the 2016 acquisition of Musk’s struggling SolarCity Corp. in the matter styled: In Re Tesla Motors, Inc. Stockholders Litigation, No. 12711-VCS  (Del. Ch., Feb. 4, 2020.)

The Court’s February 4 decision largely denied dueling summary judgment motions by plaintiff investors — who say they’ve proved Musk and the directors hid SolarCity’s virtual insolvency, and the defendants — who claim that without proof that Musk is a conflicted controller, the shareholders’ uncoerced approval vote cleanses the deal.

How did he allegedly do it?

The Court scheduled a trial for March that is expected to focus on whether Musk’s alleged dominance of Tesla was so pervasive that he could advance his self interest at the expense of the public investors, triggering a court review under the exacting requirements of the entire fairness standard.

If plaintiffs fail to demonstrate Musk’s control, the directors would be shielded by the deferential standard of the business judgment rule, which would give their actions the benefit of the doubt, and make it tough to prove breach of fiduciary duty and corporate waste charges.

Importantly, the vice chancellor rejected the defense argument that after his March 2018 decision allowed the suit to survive a motion to dismiss and move from the pleading phase to the proof stage, the plaintiffs were now obligated to show exactly how Musk used his alleged control to coerce the investors’ SolarCity deal approval. See In Re Tesla Motors, Inc. Stockholders Litigation, No. 12711-VCS  (Del. Ch., Mar. 28, 2018).

Only have to prove ability

Vice Chancellor Slights said a line of Delaware Supreme Court decisions beginning with Corwin v. KKR Financial Holdings, only requires plaintiffs to prove that an alleged controlling shareholder was so dominant that he had the ability to coerce shareholders to consent to a merger that benefited him at their expense. Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015)

But he found both parties’ summary judgment motions regarding stockholder ratification and director conflicts were not ripe because “it is desirable to inquire more thoroughly into the facts,” before deciding whether Musk possesses “inherently coercive influence over the other stockholders.”

He said, under Delaware law, a minority shareholder could be a controller if he was shown to possess “other factors” such as the “managerial supremacy” of a “hands-on” CEO and “inspirational force” whose loss would cause a “material adverse effect” on the company’s business operations. Musk is commonly referred to as the heart and soul of Tesla.

The assumption that such a conflicted controller “has strong incentives” to exert an “inherently coercive” effect on a transaction is “a finding of empirical fact rooted in the Supreme Court’s perception of how the world works,” Vice Chancellor Slights said, citing In re JCC Hldg. Co. Inc., 843 A.2d 713 n.25 (Del. Ch. 2003).

However, the vice chancellor noted that even if a trial demonstrates that Musk was Tesla’s controller at the time of the merger, defendants could still avoid liability if they could prove the deal was entirely fair to the shareholders.

Trial needed

The opinion also found summary judgment was not appropriate for either party regarding certain disclosure claims because there are genuine issues of material fact to be resolved at trial regarding whether the shareholder approval was fully informed as to:

  • SolarCity’s alleged near insolvency at the time of the merger
  • Tesla’s financial advisor’s purportedly omitted material information about the deal
  • Alleged misleading disclosures hiding Musk’s merger talks role despite his recusal
  • Whether Tesla misrepresented the status of SolarCity’s solar roof product.
  • Whether Tesla misrepresented the expected financial impact of the merger on Tesla
  • The independence of the Tesla board

“A failure adequately to disclose all material facts to voting shareholders will serve both as a bases for director liability and to preclude a stockholder vote from having a ratifying effect,” and the burden of demonstrating the vote was fully informed “falls squarely on the board,” Vice Chancellor Slights wrote.

He found that at trial, plaintiffs may prove at least four of the seven Tesla directors had divided loyalties because of their SolarCity stock holdings and/or dual positions at Musk companies and that there is a genuine material fact dispute as to whether the merger was a waste of assets.

Postscript

According to press reports, shortly after the February summary judgment opinion, the Tesla directors agreed to pay plaintiffs $60 million from the company’s insurance to settle their liability, leaving Musk the sole defendant in the scheduled 10-day March trial before Vice Chancellor Slights.

Chancery Denies Attorneys’ Fees for Successful Suit to Compel Annual Meeting

The Court of Chancery recently denied a request for attorneys’ fees that were sought pursuant to the corporate benefit doctrine despite a successful suit under Section 211 of the Delaware General Corporation Law (DGCL) to compel a company to hold an annual meeting. In Martin v. Harbor Diversified, Inc., C.A. No. 2018-0762-SG (Del. Ch. Feb. 5, 2010), the court also rejected the request for fees based on allegedly bad faith litigation tactics. A third basis for requesting fees, that the court also found unpersuasive, was the argument that the plaintiff prevailed in its demand for documents under DGCL Section 220. (As an aside, fee shifting is rarely granted in Section 220 cases, as indicated in the multitude of Section 220 decisions highlighted on these pages over the last 15 years.)

In sum, the court explained that the predominant benefit, and primary motivating factor in this case, was personal to the stockholder pursuing the claims. By comparison, when fees are granted based on the corporate benefit doctrine, which is a sub-species of the common benefit doctrine, which allows (but does not require) a court to grant attorneys’ fees based on various equitable criteria, the theory is designed to avoid the “free rider” inequity when all stockholders–and a corporation generally–benefit from the litigation efforts of one stockholder.

One example of an application of the common benefit doctrine applied to allow a attorneys’ fee request is often seen in derivative litigation when the corporation receives a lump sum payment as a result of the litigation efforts of a derivative plaintiff. By contrast, the corporate benefit doctrine applies when the corporation receives, for example, a therapeutic benefit from the litigation even if no “common fund” is created.

Delaware Supreme Court’s forum selection ruling reversal cancels stock dispute’s trip to Austria

This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.

The Delaware Supreme Court recently ruled that the Court of Chancery wrongly decided to move a Swiss holding company’s dispute over Allomet Corp.’s stock from Delaware to Austria, even though the struggling metal powder coating company did not carry its burden of proof under a financing pact’s forum selection clause, in Germaninvestments AG, et al. v. Allomet Corp., et al., Del. Supr., No. 2019 (Jan. 27, 2020).

Justice Karen L. Valihura’s Jan. 27 opinion on behalf of a three-justice panel reversed Chancery’s Rule 12(b)(3) dismissal of Germaninvestments AG’s suit to force Allomet to transfer stock, intellectual property and land in return for loans and investments that kept it afloat.

The Vice Chancellor held that under European Union regulations, companies in member nations like Austria can use a mandatory forum selection clause to designate a single jurisdiction to resolve their disputes and that’s what the 2017 Allomet Restructuring and Loan Agreement did. See Germaninvestments AG, et al. v. Allomet Corp., et al., No. 2018-0666-JRS, 2019 WL 2236844 (Del. Ch. May 23, 2019).

But in its partial reversal, the high court found that the vice chancellor wrongly put the forum burden of proof on Germaninvestments AG and should have required expert testimony throughout the briefing on the complex and novel question of the application of foreign law.

Who’s burden of proof?

The appellate panel said Allomet had the burden of proof in establishing foreign law but failed to carry it, so Delaware law should be applied to the forum selection issue, and the result is that the loan agreement’s forum clause is permissive, enabling the Chancery Court case to continue.

Recognizing that there are “very few decisions from this Court that can serve as a reference  in this area,”  it said, “we hold that the party seeking application of foreign law has the burden not only of raising the issue of the application of foreign law, but also, of establishing the substance of the foreign law to be applied.”

The dispute arose over loans and investments that Germaninvestments AG — a Swiss holding company formed to manage the Herrling family’s assets — made in Allomet and the tentative joint venture that the investors and Allomet’s owners formed in 2017 to raise capital.

In May of that year, the parties drafted a Restructuring and Loan agreement to pave the way for the July 3 formation of AHMR GmbH, an Austrian holding company in which the Herrlings and Allomet pioneer Dr. Hannjorg Hereth would eventually hold all of Allomet’s stock.

No final draft

An immediate transfusion of capital in the form of a series of loans totaling $850,000 began and the temporary pact was extended; however, according to the court record, trouble began over how the loans would translate into equity for the investors and negotiations for a permanent agreement that would address that issue broke down in May 2018.

The Hereth faction took the position that the Herrlings could not claim any stock in Allomet and deserved the return of only “a fraction” of their loans and investments, sparking the Chancery Court complaint asking for a “reissue” of stock owed to them.

The Herrlings’ suit also claimed breach of the agreements and unjust enrichment as a result of the alleged failure to transfer all of Allomet’s outstanding stock, property and intellectual property to them.

The defendants won the motion to dismiss in favor of the Vienna court even though they “provided scant information to the Court of Chancery on Austrian law, citing to Article 25 of the Brussels Regulation …but no cases in support of their Rule 12(b)(3) motion on the substance of Austrian law” Justice Valihura wrote.

The plaintiffs argued that:

·     The forum clause is neither mandatory nor enforceable with respect to their stock replacement claim under Section 168 of the Delaware General Corporation Law.

·     The defendants failed to carry their burden of proof because they made only conclusory statements on Austrian law, so the forum clause is permissive under either Delaware or Austrian law.

·     Even an Austrian court would not find that the forum clause would confer mandatory jurisdiction on Vienna courts because it should be interpreted in accordance with Delaware law.

·     Article 8 of the Brussels Regulation provides that the defendants can be sued where their corporation is domiciled — in Delaware.

The high court found that the plaintiffs had supported their arguments with citations to translated Austrian cases and that in a reply in support of their motion for re-argument on the Chancery Court decision, they had provided a law school professor’s expert opinion on Austrian law.

Justice Valihura noted the Vice Chancellor’s frustration with the sparse, eleventh-hour amount of citation and expert opinion on novel foreign law issues, but said without soliciting further information from the parties, he dismissed the complaint.

“The failure to identify, early on and properly join the issues, coupled with the lack of any expert input on the numerous nuances of Austrian and European law that were ultimately raised, lead us to conclude that the Court of Chancery erred in determining that appellees had satisfied their burden of proof,” the Justice said.

However, she affirmed the vice chancellor’s finding that Section 168 — which deals with lost, stolen or destroyed stock certificates — “does not fit” for competing stock ownership claims where the certificates are “in a vault in Austria” pending resolution of this suit.

Court of Chancery Denies Motion to Dismiss Implied Covenant of Good Faith and Fair Dealing Claim

This post was authored by R. Montgomery (“Monty”) Donaldson, a Delaware business and commercial litigator for many years, a friend and colleague of Francis Pileggi, and a follower of this blog.

The implied covenant of good faith and fair dealing has received considerable play in Delaware in recent years. In fact, over the last half-decade, the Delaware Supreme Court has weighed in on the issue in at least three noteworthy decisions, reported previously on this blog here, here, and here. As the matrix of Delaware decisional law has evolved, at least some academicians  have questioned whether it offers a uniformly reliable predictive tool in terms of how the covenant may be applied under a given set of circumstances.

Against this backdrop, a recent Delaware Court of Chancery opinion evaluating an implied covenant claim (and other contract-based claims) through the forgiving lens of a Rule 12(b)(6) challenge, In re CVR Refining, LP Unitholder Litigation, C.A. No. 2019-0062-KSJM (Del. Ch. Jan. 31, 2020), provides another useful illustration of where the implied covenant of good faith and fair dealing likely will be found to have traction, at least at the pleading stage.

Broad Contours of the Implied Covenant.

In Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, Del. Supr. No. 536, 2018 (Jan. 17, 2019), the Delaware Supreme Court described essentially two scenarios in which the implied covenant may come to bear. The first, broadly speaking, is where a contingency arises that was not anticipated by the parties, and therefore was not addressed in the explicit terms of the underlying contract. Here, the implied covenant may serve as a gap-filler. The second scenario, again broadly speaking, is where a party to the contract is given discretion to act with respect to a certain subject matter, but exercises that discretion in a manner that frustrates the purpose of the contract – that is, in a manner implicitly proscribed by the contract’s express terms.

The cases likewise delineate what cannot be accomplished by way of the implied covenant, and the list of prohibited applications is lengthy. Among them, the covenant cannot be used to:

  • rebalance economic interests after events that could have been anticipated but were not cause harm to one of the parties (see, e.g., Bandera Master Fund LP v. Boardwalk Pipeline Partners, LP, 2019 WL 4927053, *22 (Del. Ch. Oct. 7, 2019));
  • “fill a gap” where the contract in fact addresses the conduct at issue (see, e.g., Oxbow Carbon & Minerals Hldgs. V. Crestview-Oxbow Acq., LLC, 202 A.3d 482, 507 (Del. 2010)); or
  • effectively re-write the parties’ agreement (or, as famously written by former Chancellor Strine, “[t]he implied covenant of good faith and fair dealing is not a license for a court to make stuff up . . .” Winshall v. Viacom Int’l, Inc., 55 A.2d 629, 631 (Del. Ch. 2011), aff’d, 76 A.3d 808 (Del. 2013)).

Of course, these and other proscribed applications have been analyzed in detail far beyond the general scope of this post

The CVR Refining Decision

The claims in CVR Refining alleged that entities controlled by Carl Icahn engaged in a multi-step scheme (patterned after the one challenged in the Boardwalk Pipeline decision cited above) culminating in the exercise of a call right to buy out the minority unitholders of CVR Refining, L.P. at an unfair price. In particular, the minority unitholders alleged that CVR Energy (the indirect owner of CVR Refining’s general partner) launched a partial exchange offer to achieve the contractually-designated ownership threshold for exercising the call right. The general partner’s board, besprinkled with individuals closely affiliated with Icahn, did not make a recommendation concerning the exchange offer, and publicly disclosed its non-recommendation (this, in the face of a reasonably conceivable possibility that the exchange offer would trigger speculation in the market about the call right, thereby depressing the unit price). In filings made contemporaneously with the launch of the exchange offer, Icahn entities disclaimed any intention to exercise the call right after consummating the exchange offer – the predictable consequence of which (along with the exchange offer itself) was to cause analysts to speculate that the opposite was true, thereby driving down the price of CVR Refining.

As predicted, CVR later announced publicly that it was contemplating exercising its call right, causing the trading price to drop precipitously. When the call right was exercised, CVR Energy paid $393 million less than it would have had the unit price remained unaffected. Aside from breaches of the express terms of the partnership agreement, the minority unitholders alleged that the implied covenant of good faith and fair dealing prohibited the defendants from taking actions to depress the trading price of the units and undermine the price-setting mechanisms contained in the call right.

In denying the defendants’ motion to dismiss the implied covenant claim, the Court of Chancery observed:

  • that the claim implicated two partnership agreement provisions designed to protect minority shareholders – a 90-day provision and a 20-day formula. The former was designed to prevent minority unitholders from having their units called at a price below what the General Partner of its affiliates paid to purchase units in the 90 days preceding the exercise date. The latter was designed to ensure that the exercise price was unaffected by any announcement of the exercise by requiring that the price be determined with reference to the average of the daily closing prices for the 20 days immediately prior;
  • that it was reasonably conceivable that implicit in the language of the call right provision is a requirement that the defendants not act to undermine the protections afforded to unitholders by the price-protection mechanisms; and
  • that it would be “obvious” and “provocative” to demand the inclusion of an express condition that a general partner and its affiliates not subvert price-protection mechanisms through a multi-step scheme designed to manipulate the unit price (see Diekman v. Regency GP LP, 155 A.3d 358, 368 (Del. 2017) (“Partnership agreement drafters, whether drafting on their own, or sitting across the table in a competitive begotiation, do not include obvious and provocative conditions in an agreement . . .”).

Postscript

  • While narrowly construed and cautiously applied, the implied covenant of good faith and fair dealing, where properly invoked, has teeth. CVR Refining drives home the point (once again) that claims predicated on the implied covenant may survive dismissal where well-pled factual allegations support a reasonable inference that a contracting party has, in exercising otherwise-legitimate contractual rights, taken actions to undermine express contractual rights of the other party. This is especially so where the offending actions were such that explicitly proscribing them in the contract would have been too obvious or provocative. And so, the implied covenant marches on.

 

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