I have been writing an ethics column for the national publication of The American Inns of Court, called The Bencher, for about 24 years or so. My latest column appears in the current edition and is reproduced below, courtesy of The Bencher and The American Inns of Court.

Company’s Privileged Communications Must Be Provided to Board Members

By: Francis G.X. Pileggi*

A recent decision from the Delaware Court of Chancery decided an issue of first impression in Delaware: does the management of a Delaware corporation have the authority to unilaterally preclude a director of the corporation from obtaining the corporation’s privileged information? The Chancellor’s answer to the question was: no.

For purposes of this short ethics column, a practice tip for lawyers based on this case would be to remember that, generally speaking, directors and the corporation are joint clients when legal advice is given to the corporation through its directors. This general rule is especially important in the context of a fractured board with competing board factions.

The Court found in the case styled In re WeWork Litigation, No. 2020-0258-AGB (Del. Ch. Aug. 21, 2020), that when management attempted to prevent the entire board from obtaining the company’s privileged data, it had turned on its head a bedrock principle of Delaware corporate law that directors are charged with the duty to manage the company.

The issue arose in the context of dueling special committees of the board of The WeWork Company, and the efforts of one of those committees to seek privileged communications among management of the company. One special committee of the board opposed a motion to dismiss filed by two temporary directors who formed a second special committee. The first committee had filed a complaint against SoftBank Group alleging breach of contract obligations related to the purchase of the company’s stock.

There was no request for communications between the second special committee and its counsel. Rather, the first special committee sought the Company’s privileged communications about how the second special committee was formed and how it may have been influenced by the CEO of SoftBank.

One of the exceptions to the general rule that directors have unfettered access to corporate data is in those situations where “sufficient adversity exists between the director and the corporation such that the director could no longer have a reasonable expectation that he was a client of the board’s counsel.” See Kalisman v. Friedman, 2013 WL 1668205 at * 4-5. The Court explained, however, that that exception did not apply based on the facts of the WeWork case.

The Court emphasized that the board, and not management, must make any decision about withholding the company’s privileged data, after analyzing whether the directors had a reasonable expectation that they were clients of the board’s counsel. In the WeWork case, management usurped the role of the board in making that decision.

The Court’s reasoning is based on a “cardinal precept” of Delaware law that the business and affairs of a corporation shall be managed by or under the direction of a board of directors. For that reason, directors must be treated as joint clients when legal advice is rendered to the corporation through one of its officers or directors. By claiming that the directors were precluded from receiving the company’s privileged information, management contravened basic tenets of Delaware law.

When providing counsel to a corporation with a divided board, and access to privileged communications is disputed, a careful lawyer will confirm that management is not the client. Moreover, one should remember that in this context privileged communication may also be subject to review by all members of the board.

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*Francis G.X. Pileggi is the managing partner of the Delaware office of Lewis Brisbois Bisgaard & Smith, LLP. His email address is Francis.Pileggi@LewisBrisbois.com. He comments on key corporate and commercial decisions, and legal ethics topics, at www.delawarelitigation.com

16th Annual Review of Key Delaware Corporate and Commercial Decisions

By: Francis G.X. Pileggi and Chauna A. Abner

This is the 16th 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. This list does not attempt to include all important decisions of those two courts that were rendered in 2020. Instead, this list highlights notable decisions that should be of widespread interest to those who work in the corporate and commercial litigation field or who follow the latest developments in this area of Delaware law. Prior annual reviews are available here.

The Delaware Business Court Insider again published this year’s Annual Review though it appeared in two parts due to its length, in last week’s edition and in this week’s edition. Part I and Part II are reprinted below with the courtesy of The Delaware Business Court Insider. (c) 2020 ALM Media Properties, LLC. All rights reserved.

This year’s list focuses, with some exceptions, on the unsung heroes among the many decisions that have not already been widely discussed by the mainstream press or legal trade publications. For example, the Sciabacucchi; Solera; and AB Stable (Anbang) cases have already been the subject of extensive commentary by others. Links are also provided below to the actual court decisions and longer summaries.

DELAWARE SUPREME COURT DECISIONS

Supreme Court Instructs on Nuances of Fiduciary Duties of Disclosure and Loyalty

A Delaware Supreme Court decision from 2020 that deserves to be read by anyone interested in the nuances of Delaware law on the fiduciary duties of disclosure and loyalty of a manager or a director in connection with communications with stockholders or others to whom a fiduciary duty is owed, is Dohmen v. Goodman, No. 403, 2019 (Del. June 23, 2020), in which Delaware’s High Court answered a question on this topic certified from the U.S. Court of Appeals for the Ninth Circuit.

Key Takeaways:

There is a “per se damages rule” in Delaware that covers only those breaches of the fiduciary duty of disclosure involving requests for stockholder action that impair the economic or voting rights of investors. Importantly, this per se damages rule only covers nominal damages. Again, for emphasis: the per se damages rule does not apply to damages other than nominal damages. Therefore, in order to recover compensatory damages, one who proves a breach of the fiduciary duty of disclosure must also prove reliance, causation and damages. See Slip op. at 24.

The Court in its en banc opinion provides a useful overview of fiduciary duties in general, and addresses the many nuances–that change depending on the situation presented–of the duty of disclosure in particular as it relates to requests for action by stockholders or others to whom a fiduciary duty is owed.  See Slip op. at 9-10.

Brief Overview of the Case:

The procedural background of the case involved an issue of Delaware law that the U.S. Court of Appeals for the Ninth Circuit certified to the Delaware Supreme Court. In other words, the Ninth Circuit asked the Delaware Supreme Court to decide an issue of Delaware law that was originally presented to the Ninth Circuit.

This gem of a 24-page opinion, which is relatively short for many Delaware opinions, was decided based on stipulated facts, which in a very simplified way, decided a claim by a limited partner in a hedge fund, who as limited partner in a limited partnership was owed a duty by the fund manager, which was structured as an LLC. Among the claims by the limited partner was that the general partner of the limited partnership, the LLC manager, breached fiduciary duties by failing to disclose that the general partner was the only investor in the fund other than the suing limited partner, and related omissions or misrepresentations.

Delaware Fiduciary Duty Law:

In connection with its decision, the Delaware Supreme Court recited several useful truisms of Delaware law. For example, the agreements at issue did not disclaim the fiduciary duty of loyalty, and therefore, the general partner owed fiduciary duties to the limited partners, similar to those owed by directors of Delaware corporations. See footnotes 15 through 16.

The Court recited the very nuanced and multifaceted aspects of the fiduciary duties of care and loyalty that applied to communications with stockholders or limited partners. Those duties depend on the context of the communication, and whether the communication is to an individual stockholder or to a group of stockholders. See footnotes 18 through 32 and accompanying text.

The Court described several different types of factual situations which impact the application of the duty owed in connection with communications that involve a request for stockholder action, as compared to those that might involve merely periodic financial disclosures. The per se damages rule does not apply to the latter.

The Court discussed the most important Delaware decisions involving the duty of disclosure and how it is applied in various factual circumstances.

Bottom Line:

The Court explained that the per se damages rule only applies when a director seeks stockholder action and breaches their fiduciary duty of disclosure, in which case a stockholder may seek equitable relief or damages. That is, when directors seek stockholder action, and the directors fail to disclosure material facts bearing on that decision, a beneficiary need not demonstrate other elements of proof, such as reliance, causation or damages. This rule only applies to nominal damages and does not extend to compensatory damages. See Slip op. at 10 through 11.

Link to original post on these pages about this case.

 

Supreme Court Interprets Key Words in Agreement

A Delaware Supreme Court decision from May 2020 is noteworthy for the approach it takes in determining the meaning of a word in an agreement, for example, by parsing the syntax and sentence structure where the word at issue appears in the agreement. In Borealis Power Holdings Inc. v. Hunt Strategic Utility Investment, L.L.C., No. 68, 2020 (Del. May 22, 2020), the Delaware Supreme Court provides useful guidance about how to determine the meaning of a key word in an agreement. In this matter, despite a lengthy definition in the agreement of the word “transfer”, the parties still disputed its meaning.

Background:

The underlying dispute involved a complex constellation of interrelated entities which the Court provided a graphic description of by way of a chart. The essential facts on which the dispute was based involved the interpretation of an LLC agreement which imposed restrictions on the transfer of LLC units and provided for the right of first refusal and other provisions triggered by a “transfer.” Several terms were defined in the agreement–with rather lengthy definitions–but the definitions did not provide sufficient clarity. The most consequential definition that was disputed was the meaning in the context of the agreement of the word “transfer.”

The problem presented to the Court of Chancery was whether the sale of an interest triggered either a right of first refusal and/or a right of first offer, and if both applied, which was to be given priority.

The Court of Chancery concluded that a sale by Hunt of its shares to Borealis would be a “transfer.” The Supreme Court had a different view.

The finding by the Court of Chancery that the purchase of Hunt’s shares constituted a transfer, triggered the requirement to offer the shares to Sempra. As a result of other consequences of that holding, the Court of Chancery found that Sempra was the only party with the right to purchase the Hunt shares, and entered judgment in favor of Sempra. This expedited appeal followed an expedited trial. It remains noteworthy that this opinion came only 30 days after the final submission of the appeal to the Supreme Court.

Analysis by the Supreme Court:

The Supreme Court held that the right of first refusal in Section 3.9 of the agreement at issue is only triggered by transfers by the Minority Member and its Permitted Transferees, and that Hunt is neither. Put another way, Delaware’s High Court held that the fact that the right of first refusal is only triggered by transfers by the Minority Member is dispositive in favor of Borealis, regardless of whether the Hunt Sale could be said to effect an indirect transfer.

One of the agreements involved was governed by New York law and one was governed by Delaware law–but the Court noted that the law of both states as it relates to contract interpretation in this case is the same. See footnote 22.

Two other footnotes contain important observations of Delaware law that are especially worth remembering:

(1) The management of an LLC is vested in proportion to the then-current percentage or other interest of members in the profits of the LLC owned by all the members, and “the decision of members owning more than 50% of the said percentage or other interest in the profits [is] controlling.” Footnote 27; see Section 18-402 of the Delaware LLC Act.

(2) Also noteworthy is the observation by the Court that an argument that was only raised in a footnote would justify “passing over it” because footnotes, according to Delaware Supreme Court Rules, “shall not be used for argument ordinarily included in the body of a brief.” Footnote 28. See Del. Sup. Ct. R. 14 (d)(iv).

The most noteworthy parts of this pithy 21-page decision are found in the last few pages which include the core of the Court’s reasoning.

In particular, the most memorable part of the Court’s reasoning is the parsing by the Court of the syntax and sentence structure of the agreement in order to interpret the meaning of a particular word in the agreement. The Court focuses on the “subject of the operative sentence” in Section 3.1, of which “the verb phrase ‘may only transfer’ serves as the predicate.” The Court further explains that the subject of the operative sentence is neither accidental nor unimportant because it is the same subject for which the verb phrase “intends to transfer” serves as the predicate in section 3.9.

The Court added that the subject, which is stated conjunctively, does not include Hunt. Therefore, the Court reasoned that it was unnecessary and inappropriate to parse the definition of transfer, as defined in the agreement, to determine the scope of Section 3.1 and Section 3.9, because: “the subjects of the opening sentences in both of those sections do that for us.” See Slip Op. at 20 – 21.

In sum:

Although the detailed factual background needs to be reviewed more closely in order to fully understand the Court’s reasoning, for anyone who wants to understand Delaware law regarding proper contract interpretation, and interpretation of the meaning of a word, even when it is defined in an agreement, this opinion is must-reading.

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Delaware Supreme Clarifies Contract-Based Right to Corporate Records

A Delaware Supreme Court opinion issued in July 2020 should be required reading for anyone interested in the latest iteration of Delaware law on the contract-based right to demand “books and records” in the alternative entity context. Delaware’s High Court ruled in Murfey v. WHC Ventures, LLC, No. 294, 2019 (Del. July 13, 2020), that the Court of Chancery erred by interjecting into a limited partnership agreement a statutory requirement from Section 17-805 of the Delaware LLC Act that did not appear in the parties’ agreement.

The great importance of this ruling can best be appreciated by emphasizing that the Court did not opine in any manner on the statutory requirements for demanding books and records of a business entity–about which we recently provided an overview of key decisions on this topic, with the title of: Demands for Corporate Documents Not for the Fainthearted.

We will add to that characterization of Delaware decisions interpreting statutory provisions for demanding corporate documents, a general observation based on the instant decision: Contract-based demands for books and records of business entities are not for the fainthearted either. A few reasons that support our observation include the following:

  • This Supreme Court decision features the en banc Justices split 3-2, along with a less-than-common reversal of a Chancery decision. So, that procedural note underscores that 6 of the best legal minds in Delaware (5 jurists on the high court and 1 in Chancery rendering opinions in this case) cannot find unanimity on this issue.
  • The original demand in this case was made on January 10, 2018. The Chancery complaint was filed in September 2018. Through no fault of the court system, this final decision on appeal came down on July 13, 2020. About 2 years is still lightening-fast for the period from filing a complaint to a final decision by a state’s highest court, but that still implies substantial legal fees and the need for financial and other types of stamina for someone who is serious about seeking corporate records.
  • Although this decision provides authoritative guidance on this nuance of Delaware business litigation, a careful parsing of the opinion still reveals a fertile field for indeterminacy–which makes it a challenge for the lawyers toiling in this vineyard who are trying to predict the outcome of this type of contract interpretation dispute–even if one need not be concerned with applying the multitude of court decisions applying the statutory provisions for inspection rights in this context.
  • We will end our introductory observations on a positive note: despite the plethora of case law interpreting the various statutory provisions for demanding books and records, such as Section 220 and Section 18-305, this decision is a welcome addition to the relatively few published Delaware opinions that address the purely contract-based right to books and records of an alternative entity.

Basic Factual Background:

Based on the assumption that readers of this post are familiar with the basics of Delaware law in this area, we are only highlighting the irreducible minimum amount of facts to provide context for the key legal principles announced.

This case followed a typical pattern. The company provided some documents initially, and at the time of trial the only issue was the very limited documents the company refused to produce.

Somewhat unusual was that only one specific type of document was the subject of the trial court decision and the appeal: the K-1 of the other limited partners in the limited partnership. Although the company allowed counsel for the plaintiff and the plaintiff’s valuation expert to review those K-1s, they refused to let the plaintiffs themselves review the K-1s of other limited partners–even subject to the common confidentiality agreement.

The limited partnership agreements involved allowed for a rather broad scope of documents to be demanded, including tax returns which were specifically listed as being subject to production. The company took the curious position that a K-1 (of other limited partners) was not part of the tax returns of the company–or at least not within the scope of documents they need to produce.

Primary Issue Addressed on Appeal:

Whether the Court of Chancery erred by injecting into the terms of the agreement that provided for a right to books and records–additional statutory prerequisites. Short answer: yes.

High Court’s Reasoning–Key Takeaways:

The majority opinion made quick work of dispensing with the defense that valuation was not a valid basis for requesting the disputed documents or that tax returns were not needed to complete a valuation. See, e.g., footnotes 65 and 66 as well as related text. More notably, the Court found that the statutory notion of a “proper purpose” was not applicable to contract-based demands. See, e.g., footnote 53 and accompanying text (quoting with approval prior decisions so holding.)

Also noteworthy is the Court’s reference to dictionary definitions of words, including prepositions, at issue in this case. See footnotes 32 and 33.

The Court reviewed many prior Delaware decisions that addressed when, if ever, it would be appropriate to infer words or conditions that do not appear in the terms of an agreement, such as statutory prerequisites. Slip op. at 18-25.

A key part of the Court’s reasoning was that: because the partnership agreements involved

… do not expressly condition the limited partner’s inspection rights on satisfying a “necessary and essential” condition [a statutory concept], and given the obvious importance of tax return and partnership capital contribution information to the Partnerships’ investors, as evidenced by the agreements, we are not persuaded that such a condition should be implied. Slip op. at 25.

The majority opinion’s “rebuttal” of the dissenting opinion deserves to be read in its entirety. Slip op. at 32 to 37. Two especially notable excerpts:

  • “The words ‘necessary and essential’ do not appear in the written agreements”. Slip op. at 35.
  • “… we also do not agree that the parties to a limited partnership agreement have to expressly disclaim any conditions applied in the Section 220 context (or the Section 17-305 context….)” Footnote 85.

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Supreme Court Rejects Two Common Defenses to Section 220 Demands

A recent decision from the Delaware Supreme Court provides hope to stockholders who seek to obtain corporate documents pursuant to Section 220 of the Delaware General Corporation Law to the extent that Delaware’s High Court removed two common defenses that companies use to oppose the production of corporate records to stockholders. In AmerisourceBergen Corporation v. Lebanon County Employees Retirement Fund, No. 60, 2020 (Del. Dec. 10, 2020), the two most important aspects of the ruling are that:

(i) A stockholder making a Section 220 demand need not demonstrate that the wrongdoing being investigated is “actionable;” and

(ii) When the purpose of a Section 220 demand is to investigate potential wrongdoing and mismanagement, the stockholder is not required to “specify the ends to which it might use” the corporate records requested (i.e., exactly what it will do with the documents it receives).

Over the last 15 years we have highlighted many of the frustrating aspects of decisions construing Section 220 to the extent that one needs stamina and economic fortitude to pursue what oftentimes is an unsatisfying result. See, e.g.,recent overview on this topic.

This decision should be in the toolbox of every corporate litigator not only because it announces a new path for Section 220 cases and reminds us of the basic prerequisites of the statute, but also in light of it partially overruling and distinguishing some prior cases. This opinion also confirms that several Chancery decisions that were not in harmony with this decision should no longer be followed.

Key Takeaways:

       One of the most important takeaways from this decision is that the Court clarified that when the purpose of a Section 220 demand is to investigate potential mismanagement, the stockholder is “not required to specify the ends to which it might use” the corporate documents requested.  See page 22.

       The second most important takeaway from this case is the Court’s holding that a stockholder pursuing a Section 220 demand need not demonstrate that the alleged wrongdoing is “actionable.” See page 25.

       The three prerequisites (not including the many nuances) for successfully pursuing a Section 220 demand to inspect a corporation’s books and records requires a stockholder to establish that: (1) such stockholder is actually a stockholder; (2) such stockholder has complied with Section 220 respecting the form and manner of making demand for inspection of such documents; and (3) the inspection such stockholder seeks is for a proper purpose. See pages 12-13.

       The Court recited the many examples of proper purposes that have been recognized to be reasonably related to the interest of the requesting stockholder. See footnote 30 for a lengthy list, which includes “to communicate with other stockholders in order to effectuate changes in management policies.”

       The Court reiterated the well-known requirement that when the proper purpose of a stockholder making a Section 220 demand is to investigate potential mismanagement, a stockholder needs to demonstrate “a credible basis” from which the court may infer that “there is possible mismanagement that would warrant more investigation.” See page 15.

       Although a credible basis of wrongdoing needs to be presented by a preponderance of the evidence to pursue the proper purpose of investigating potential wrongdoing, a company will not be permitted to mount a merits-based defense of such potential wrongdoing. See page 37.

       Moreover, while trying to harmonize prior decisions on these nuances, the Court observed that some of the decisions struck a discordant note. See footnote 109.

       The Court also affirmed the following two aspects of the Court of Chancery’s ruling: (1) regarding the scope of documents, the Court found that it was appropriate to include a requirement that the company produce officer-level materials and (2) the high Court found it was not an abuse of discretion to order a Rule 30(b)(6) deposition–because the company refused to describe the types and custodians of corporate records that it had in response to discovery requests. See pages 39 and 43.

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DELAWARE CHANCERY COURT DECISIONS

Chancery Provides Refreshing Section 220 Guidance

The Delaware Court of Chancery rendered a decision in November 2020 that belongs in the pantheon of noteworthy Court opinions addressing the nuances, first principles and practical challenges regarding Section 220 of the Delaware General Corporation Law. There are many decisions on this topic addressing the right of stockholders to demand inspection of corporate records, but few are as “blogworthy” as this decision in Pettry v. Gilead Sciences, Inc., C.A. No. 2020-0173-KSJM (Del. Ch. Nov. 24, 2020). Compare another pantheon-worthy Chancery decision earlier this year in AmerisourceBergen. See Lebanon Cnty. Emps. Ret. Fund v. AmerisourceBergen Corp., 2020 WL 132752 (Del. Ch. Jan. 13, 2020), which was affirmed by the Delaware Supreme Court.

Weighing in at 69-pages, this opinion’s length is indicative of the complexities of Section 220 that are belied by the apparent simplicity of the statute. Our favorite part of this decision is the acknowledgement that when pursuing the statutory rights that Section 220 appears to allow, one can easily be stymied by the gamesmanship of companies who can play a war of attrition, usually with impunity, in light of the asymmetrical economics involved. See Slip op. at 3-5 and footnote 6 (citing an article addressing the obstacles to pursuing Section 220 rights: James D. Cox, et al., The Paradox of Delaware’sTools at Hand Doctrine: An Empirical Investigation,” 75 Bus. Law. 2123, 2150 (2020)).

Similar observations about the practical hindrances, economic and otherwise, to utilizing Section 220 have often been the topic of blog posts over the last 15 years. See, e.g., recent blog post explaining that Section 220 cases are not for the fainthearted.

This Gilead case provides guidance on an important topic that warrants a very lengthy analysis. We provide highlights via bullet points, and then interested readers can click on the above link and read all 69-pages.

The bullet points that we find to have the most widespread applicability and importance are the following:

• The Court criticizes the trend in which companies often inappropriately litigate the underlying merits of a potential, future plenary suit as opposed to addressing whether the prerequisites have been met for a Section 220 demand, as well as the tendency of companies to otherwise prevent stockholders from using Section 220 as a “quick and easy pre-filing discovery tool.” Slip op. at 3-4.

• The Court provides many quotable explanations of the “credible basis” standard that must be satisfied in order to rely on the proper purpose of investigating suspected wrongdoing. The Court emphasizes that this “lowest possible burden of proof” does not require a stockholder to prove that any wrongdoing actually occurred; nor does it require a stockholder to show by a preponderance of the evidence that wrongdoing is even probable. Slip op. at 23, footnotes 103 and 104.

• Rather, the Court instructed that the recognized proper purpose for using Section 220 to investigate suspected wrongdoing is satisfied when there is a credible basis to suspect merely the “possibility” of wrongdoing. Id. at 24, n.106.

• The Court addresses the common tactic used by companies challenging a proper purpose when they assert that the “stated proper purpose is not the actual proper purpose for the demand.” This opinion teaches that in order to succeed in such a defense, the company must prove that the “plaintiff pursued its claim under false pretenses. Such a showing is fact intensive and difficult to establish.” See footnote 153 and accompanying text.

• The Court made quick work of dispensing with the issue of standing in Section 220 cases. The Court reasoned that the standing argument in this case was in reality a Potemkin Village (our words) for the company’s challenge to the viability of derivative claims that the plaintiffs might pursue in the future. Although the Court discussed standing under Section 220 in general, it also underscored that a Section 220 proceeding does not warrant a trial on the merits of underlying claims. Slip op. at 41–42.

• The Court instructed that generally Section 220 plaintiffs need not specify the “end-uses” of the data requested for their investigation. Slip op. at 49.

• The Court also provided helpful practical tips about the scope of production required once the preliminary prerequisites of Section 220 have been satisfied. The Court noted that in some instances the company will be required to provide more than simply formal board materials. See Slip op. at 51-54.

• The opinion acknowledged that in some instances after limited discovery in a Section 220 action, plaintiffs can refine their requests with greater precision and that in some cases the Court has asked the plaintiffs to streamline their requests. See Slip op. at 63.

• In response to the Court being vexed by the overly aggressive tactics of the company, the Court invited the plaintiff to “seek leave to move for fee shifting.” As one example of the Court’s observation that the company was taking positions for no apparent purpose other than obstructing the exercise of the statutory rights of the plaintiff, the Court noted that the company refused to produce even a single document before litigation commenced.

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Must-Read Chancery Decision for Buyers of Businesses Whose Value Depends on Retaining Customer Relationships

The Delaware Court of Chancery in August 2020 addressed the issue of whether a seller was liable for not disclosing the notification it received prior to closing that one or more key customers were terminating their relationship with the seller’s business. Swipe Acquisition Corporation v. Krauss, C.A. No. 2019-0509-PAF (Del. Ch. Aug. 25, 2020). The Court’s decision and other decisions cited below must be read by anyone who seeks a deep understanding of Delaware law on this topic.

Key Issue Addressed:

When will a fraud claim survive in connection with a purchase agreement that restricts claims for misrepresentations and limits claims for indemnification? In this case, most of the motion to dismiss was denied, but one of the reasons this decision is noteworthy is because it exposes the lack of a bright-line-rule on this issue when compared to other decisions addressing the same or similar issues–depending on the specific terms of the anti-reliance clause involved and the specific claims of fraudulent misrepresentations or omissions.

As an indication of how common this issue is, a few days before this ruling the Court of Chancery issued another decision that addressed the issue: Pilot Air Freight, LLC v. Manna Freight Systems, Inc., No. 2019-0992-VCS (Del. Ch. Sept. 18, 2020).

Key Facts of Swipe case:

This case involves a dispute over the lack of disclosure by the seller prior to closing when the seller learned that a key customer was claiming to terminate its business relationship even though the sales price was impacted by the existence of key customers. The sellers knew that if the buyers learned of the termination by the key customer involved that the deal might not close. See Slip op. at 8. Nonetheless, the sellers did not inform the buyers of the termination of the key customer at issue. Moreover, the sellers did not amend any of the financial information provided to the buyers, which had then become stale. Id. at 9. Based on weaker-than-expected performance before the closing, the buyers and the sellers did agree to reduce the purchase price even though the loss of the key customer was not disclosed.

Key Principles of Law with Widespread Applicability:

  • The Court cited to multiple cases to explain when an anti-reliance clause will not bar a fraud claim. See Slip op. at 28-29.
  • The Court also elucidates when a fraud claim and a contract claim will not be considered duplicative; when both can proceed at the preliminary stage of a case; and when a contract claim and a fraud claim will not be considered boot-strapped. See id. at 31-33.
  • The Court explained why duplicative claims may often survive at the motion to dismiss stage. See footnote 61 and accompanying text.
  • The Court explained the primacy of contract law in Delaware, and when parallel contract claims and breach of fiduciary duty claims may not proceed in tandem. See footnote 58 and accompanying text.

In addition to the cases cited above on the topic at hand, this decision should be compared with the Delaware Superior Court’s Infomedia decision that was issued just a few short weeks before this Chancery ruling. Of course, the exact terms of the applicable agreements and the detailed circumstances are often determinative, but in the unrelated Delaware Superior Court decision about a month earlier, the Court concluded that the failure to inform the sellers shortly before the execution of an asset purchase agreement that key customers intended to terminate their service contracts, even though written notice had not yet been received, would not be a sufficient basis for fraudulent misrepresentation claims due to anti-reliance provisions in an asset purchase agreement, thereby resulting in a grant of the motion to dismiss, based on the terms of the agreement involved in that case. See Infomedia Group Inc. v. Orange Health Solutions, Inc. (Del. Super. July 31, 2020).

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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 provides 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).

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Chancery Explains Proper Methods to Expand Board Size and to Fill Board Vacancies

A recent Delaware Court of Chancery decision provides a primer on the proper way to expand the size of a board of directors and the proper way to fill board vacancies, as well as explaining the difference between a de facto and a de jure director. See Stream TV Networks, Inc. v. SeeCubic, Inc., C.A. No. 2020-0310-JTL (Del. Ch. Dec. 8, 2020).

This opinion should be at the fingertips of every corporate litigator who is called upon to address whether:

(1) the size of a board of directors was properly expanded;

(2) director vacancies were properly filled; or

(3) whether the actions of a de facto board member were binding even if because of technical mistakes that director was not properly appointed such that she would qualify as a de jure director.

Many additional consequential statements of Delaware law with widespread utility are included in this consequential 52-page decision.

Highlights:

       The Court describes the well-known prerequisites for obtaining a preliminary objection. See page 16.

       The Court provides a tutorial, with copious citations to statutory and caselaw authority, to explain: (i) how to expand the size of the board of directors; (ii) who has the authority to expand the size of the board; (iii) how to fill vacancies on the board; and (iv) who is authorized to fill vacant board seats. See pages 17 to 20.

       This opinion features a maxim of equity that would be useful to have available when the situation calls for it: equity regards as done what ought to have been done. See page 20.

       The Court explained that only the charter or the bylaws can impose director qualifications, and in any event those qualifications must be reasonable. See page 21.

       The Court explained that a director could not agree to conditions of service as a board member that would be contrary to the exercise of the fiduciary duties of a director. See page 22.

       An always useful reminder of the three tiers of review of director decision-making are provided. Those three tiers are: (i) the business judgment rule; (ii) enhanced scrutiny; and (iii) entire fairness. See pages 50 to 51.

       In addition to explaining when those three tiers apply, the opinion also regales us with a classic recitation of the business judgment rule as the default standard:

” . . . the default standard of review is the business judgment rule, which presumes that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interest of the company.” See page 50.

      This decision teaches that unless one of the rule’s elements is rebutted, the Court merely looks to see whether the business decision made was rational in the sense of being one logical approach to advancing the corporation’s objective.

       The Court explains the difference between a de facto director and a de jure director, and which actions of a de facto director are binding.  See pages 23 to 25.

       Another extremely important aspect of this decision (which takes up the majority of the 50-plus pages) is a deep dive into the historical foundations of Section 271 of the Delaware General Corporation Law which applies generally to the sale of most or all of the assets of a corporation, and which would typically require stockholder approval. See page 27 through 48.

       The Court supports with detailed reasoning and extensive footnote support its conclusion that Section 271 does not apply to an insolvent corporation that transfers assets to a secured creditor. Compare DGCL Section 272 (allows directors to mortgage corporate assets).

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Delaware Court of Chancery Provides Rule 11 Insights

There are relatively few Chancery decisions on Rule 11 compared with more common corporate and commercial litigation issues that are the subject of Chancery opinions, and an October 2020 letter decision provides insights into why there are not more rulings on Rule 11. In POSCO Energy Co., Ltd. v. FuelCell Energy, Inc., Civil Action No. 2020-0713-MTZ (Del. Ch. Oct. 22, 2020), in which a motion for leave to amend under Rule 15 was granted without awarding fees, while distinguishing both the Lillis and Franklin Balance cases, the Court explained that Rule 11 should not be casually raised, but that in any event a requirement for invoking it is to provide separate written notice and an opportunity to cure, as opposed to including it as part of a motion addressing other issues as well.

The Court explained that:

FuelCell has invoked Court of Chancery Rule 11 casually and repeatedly in this matter.21 The Court may only determine if Rule 11(b) was violated “after notice and a reasonable opportunity to respond,” and a litigant may only initiate those proceedings by “[a] motion for sanctions . . . made separately from other motions or requests.”22  Under that plain language, if FuelCell seeks sanctions for conduct it believes violates Rule 11, it must do so in an independent motion, not in argument opposing unconditional leave to amend. And, in my view, it is distracting, detrimental to the famed collegiality of the Delaware bar, and counterproductive to the “just, speedy and inexpensive determination” of judicial proceedings to summon Rule 11 in rhetoric.23

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Chancery Declines to Order Reserve for Fraud Claims Against Dissolving Corporation Under DGCL Section 280

There remains a relative paucity of opinions addressing the nuances of the dissolution statute under DGCL Section 280, compared to the Delaware decisions addressing other sections of the DGCL, so we refer to a September 2020 Court of Chancery decision that denies a Motion for Reargument under Rule 59(f) of a ruling that rejected a request to set aside a reserve for a fraud claim–even though the letter ruling was barely three-pages long–in the matter styled In re Swisher Hygiene, Inc., 2018-0080-SG (Del. Ch. Sept. 4, 2020). The prior decision was highlighted here.

The Court explained that the allegations did not state a “creditor claim”, though the ruling expressly did not prejudice the right to “bring litigation to determine” the fraud claim, which related to disputed ownership of stock in the company being dissolved.

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Chancery Enforces Forum Selection Clause in Charter for Inspection Demand

One of our selected Court of Chancery decisions is almost as noteworthy for what it did not decide as for what was decided. In JUUL Labs, Inc. v. Grove, C.A. No. 2020-0005-JTL (Del. Ch. Aug. 13, 2020), Delaware’s Court of equity enforced an exclusive forum selection clause in a company charter, based at least in part on the internal affairs doctrine, to prevent a stockholder in a Delaware corporation from filing suit in California in reliance on a California statute to demand the inspection of corporate records, notwithstanding a California statute that appears to allow a stockholder to sue in California for corporate records if the Delaware company has its principal place of business in California.

What the Court did not decide is whether a stockholder may contractually waive her rights under DGCL section 220. Count this writer as a skeptic on that point. The Court reviewed several overlapping agreements, such as a stock option exercise agreement, that the stockholder signed and that purported, at least in the company’s view, to waive inspection rights under DGCL section 220. Some of the agreements were governed by Delaware law and some by California law.

This decision could be the topic of a law review article due to the many core principles of corporate law and doctrinal underpinnings the Court carefully analyzes. But, we only provide a few bullet points with an exhortation that the whole opinion be reviewed closely.

  • The Court provides an in-depth discussion of the foundational concepts that undergird the internal affairs doctrine as it applies to the request for corporate records, as well as related constitutional issues that arise.
  • But footnote 7 acknowledges contrary authority that suggests that a local jurisdiction may apply its law to a demand by a local resident for corporate records of a foreign corporation.
  • The Court compares DGCL section 220 with its counterpart in the California statutory regime.
  • The exclusive forum selection clause in the charter was addressed, and the Court explained that but for this provision, the California court would be able to apply DGCL section 220.
  • Importantly, the Court emphasized that is was not deciding whether a waiver of DGCL section 220 rights would be enforceable. Although at footnote 14 the Court provides citations to many Delaware cases that sowed doubt about the viability of that position–but then the Court also cited cases at footnote 15 that more generally recognized the ability to waive even constitutional rights.
  • Footnote 16 cites to many scholarly articles, and muses about the public policy aspects of the unilateral adoption of provisions in constitutive documents, such as forum selection clauses in Bylaws. Early in the opinion, at footnote 7, by comparison the Court waxes philosophical about the concept of the corporation as a nexus of contracts–as compared to it being viewed as a creature of the state. The latter view has implications about the exercise of one state’s power in relation to other states, especially when private ordering may be seen as private parties exercising state power by proxy.

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Chancery Clarifies Nuances of Section 220 Stockholder Demand for Inspection Rights

A July 2020 Delaware Court of Chancery opinion provides insights into nuances of DGCL Section 220 as it relates to the rights of stockholders to inspect corporate books and records, and deserves to be in included in the pantheon of Delaware decisions on this topic. It must be read by anyone seeking a complete understanding of Delaware law on Section 220. In Woods v. Sahara Enterprises, Inc., C.A. No. 2020-0153-JTL (Del. Ch. July 22, 2020), the Court provided warmly welcomed clarity about important nuances of DGCL Section 220 with eminently quotable passages for practitioners who need to brief these issues. See generally overview of takeaways from 15 years of highlighting Section 220 cases, and compare a recent Delaware Supreme Court decision about contract-based rights to inspect corporate books and records.

This short overview will only provide several of those worthy passages in the format of bullet points.

Among the more noteworthy aspects of this notable decision are the following.

  • A consequential aspect of this jewel of a decision is the instruction by the Court that there is no basis in Delaware law to require a stockholder demanding corporate records under Section 220 to explain why the stockholder wants to value her interest in the company–in order to satisfy the recognized proper purpose of valuation. See Slip op. at 11; and 14-15.
  • The Court provided an extremely helpful list of many recognized “proper purposes” needed to be shown to satisfy Section 220. See Slip op. at 8-9.
  • The Court also recited several examples of what showing is recognized as sufficient to satisfy the “credible basis requirement” to investigate mismanagement pursuant to Section 220. See Slip op. 18-19.
  • An always useful recitation of the basic elements of the fiduciary duty of directors of a Delaware corporation and the subsidiary components of the duty of loyalty and care, are also featured. See Slip op. at 20.
  • The Court categorized the specific requests for documents in this case as follows: (i) formal board materials; (ii) informal board materials; and (iii) officer-level materials. Then the Court expounds on the different focus applicable to each category.
  • Notably, after quoting the actual document requests, the Court found that some of them were overly broad–but the Court edited and narrowed some of the requests before concluding that the company was required to produce the Court-narrowed scope of documents.

Bonus supplement: Prof. Bainbridge, a nationally prominent corporate law scholar, provides learned commentary on this case and Section 220 jurisprudence generally. Readers should recognize the good professor as the prolific author who scholarship has been cited in Delaware Court opinions.

Link to original post. 

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*Francis G.X. Pileggi is the managing partner of the Delaware office of Lewis Brisbois Bisgaard & Smith LLP, and the primary author of the Delaware Corporate and Commercial Litigation Blog at www.delawarelitigation.com.

**Chauna A. Abner is a corporate and commercial litigation associate in the Delaware office of Lewis Brisbois Bisgaard & Smith LLP.

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 endorsed a ruling that invalidated a fired QLess Inc. CEO’s “boardroom coup” because he violated his fiduciary duty by using affirmative deception to regain his position and corporate control–even though he did nothing technically illegal in an “ambush” directors’ meeting, in Bäcker, et al. v.Palisades Growth Cap. II, L.P.,  No. 156, 2020 opinion issued (Del. Supr. Jan. 15, 2021).

The high court’s en banc opinion rejected an appeal by ex-CEO Alex Bäcker and his director appointee father Riccardo of a Chancery Court decision that they had misused a temporary 2-1 board majority created by recent director resignations to unfaithfully trick their way to power.

The Supreme Court’s opinion is noteworthy for its unanimous rulings that:

  • The Chancery Court’s finding of affirmative deception was not clearly erroneous.
  • The Court of Chancery did not impose an equitable notice requirement for regular board meetings.
  • Appellants failed to properly raise an equitable participation defense in the Chancery Court, and
  • The Court of Chancery did not exercise its equitable powers to grant relief for a de facto breach of contract claim because there was a viable, separate breach of duty charge.

Background

In 2009, Appellant Alex Bäcker co-founded QLess Inc., a privately held Delaware corporation headquartered in California that produces and licenses a virtual queue management system that reduces the time retail customers must wait in line for services. He served as CEO for ten years until forced out in 2019 amid employee charges that he created a toxic work environment.

But the court record said he remained the majority common stock shareholder with the power to name two directors to a five-member board and when two directors of that board unexpectedly resigned before a November 2019 board meeting, he seized an opportunity to hijack the appointment of new CEO/director Kevin Grauman.

At the beginning of that board meeting, before the installation of Grauman as a director, Alex and his father held a 2-1 majority and suddenly sprung a surprise agenda on the board, voting to fire Grauman and restore Alex as CEO. They were able to accomplish this coup by deceiving the third director into believing they supported Grauman.

The Chancery Court ruling

Palisades Growth Capital II, L.P., the majority holder of QLess preferred stock, filed suit asking the Chancery Court to invalidate Bäcker’s actions and after a paper trial, the court found the defendants breached their fiduciary duties as QLess directors. The court found that the Bäckers affirmatively deceived Palisades director appointee Jeff Anderson–the third director–into attending the November meeting, creating the necessary quorum. Palisades Growth Cap. II, L.P. v. Bäcker, 2020 WL 1503218 (Del. Ch. Mar. 26, 2020).

“After having affirmatively represented to [the board] that Defendants supported Grauman’s appointment to the Board, keeping mum as they planned their ambush was inequitable,” the Chancery Court said.

The appeal

On appeal, the Bäckers argued that the Court of Chancery erred by relying on clearly erroneous interpretations of evidence and applying incorrect legal standards to invalidate the actions that the Bäckers took at the November 15 board meeting.

Writing for the unanimous high court, Justice Tamika Montgomery Reeves said, “‘Whether . . . an equitable remedy exists or is applied using the correct standards is an issue of law and reviewed de novo,’ but . . . ‘application of those facts to the correct legal standards . . . are reviewed for an abuse of discretion.’”

The finding that the Bäckers deceived Anderson was not clearly erroneous

At bottom, the determination of whether the Bäckers’ conduct was deceptive was a factual one, the Justice wrote. “Unlike the mixed questions of fact and law that the Bäckers identify, the court did not need to consider legal principles to determine whether the Bäckers tricked Anderson.”

The finding of affirmative deception was not clearly erroneous

This Court has long recognized that “inequitable action does not become permissible simply because it is legally possible,” the high court held. “Under Delaware law, “director action[s] [are] ‘twice-tested,’ first for legal authorization, and second [for] equity.” That’s why stockholders can entrust directors with broad legal authority precisely – “because they know that that authority must be exercised consistently with principles of fiduciary duty.”

Anderson’s attendance and actions at the meeting not preclude equitable relief

“Nothing in the case law that the Bäckers present suggests that Delaware law tolerates deception related to regular board meetings, and we can think of no good reason why deception would be allowed for regular board meetings, but forbidden for special board meetings,” the Justices said.

No extracontractual relief was provided under the voting agreement

The Bäckers argued that If the fiduciary claims relate to obligations that are expressly treated’ by contract, then the court must review those claims as breach of contract claims and any fiduciary duty claims will be dismissed. But the justices said, “This bootstrapping case law only requires dismissal where a fiduciary duty claim wholly overlaps with a concurrent breach of contract claim,” and that is not the case in this matter.

A recent post on the well-read blog of Prof. Stephen Bainbridge, our favorite corporate law scholar whose many publications are cited in Delaware court decisions, linked to an article that lawyers and other followers of Delaware corporate law should be interested in, by an eminent Delaware corporate litigator, on the topic of how much weight should be given to bench rulings, sometimes referred to as transcript rulings, from the Delaware Court of Chancery. As a matter of Delaware practice, such rulings are often cited in briefs and even appear in published opinions of Delaware courts.

A recent Delaware Court of Chancery opinion interpreted related agreements that included forum selection clauses that were conflicting.  In Mack v. Rev Worldwide, Inc., C.A. No. 2019-0123-MTZ (Del. Ch. Dec. 30, 2020), the court addressed forum selection provisions in two related agreements which the court treated as one because they were incorporated by reference.

The court was asked to decide whether Delaware was the proper forum when one of the forum selection clauses required courts in Texas to address certain issues–and the other forum selection provision provided for a California court to hear disputes.

Key Takeaways:
● The court recited the well-established Delaware law about the enforceability of forum selection clauses generally.  Slip op. at 15 to 17.
● The court also addressed Rule 12(b)(3) motions challenging venue and whether arguments required to be made in an initial Rule 12 motion are waived if all the grounds for such motions are not explained, as well as the impact of a second motion under Rule 12 in connection with an amended complaint.  The court explained why those arguments would generally not be waived, even if all the grounds for such a motion were not recited in the original motion.
● The court also observed that in some instances non-signatories to a forum selection clause may also be bound by it.
● The court reasoned that unlike the typical situation where conflicting forum selection clauses choose Delaware and another forum, in this instance competing forum selection clauses both required litigation in states outside of Delaware. Therefore, the court determined that because neither of the parties chose Delaware, a court in one of the other two forums selected would need to decide which of them would address the merits of the case.

Applying a contractual fee-shifting provision when it is not clear which party prevailed, is a topic that does not benefit from an extensive body of case law, relatively speaking. The recent Court of Chancery decision in Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, C.A. No. 7906-VCG (Del. Ch. Dec. 31, 2020), provides an additional source of authority for resolving this issue of outsized importance to lawyers and clients alike.  See Slip op. at pages 15 and 16.

The court also addressed when an “ordinary” contractual indemnification provision might allow for first-party claims for fee shifting, and refers to the recent Chancery decision in International Rail Partners, highlighted on these pages, to explain that only when a contract explicitly provides for first-party claims in an ordinary or “bilateral commercial” contractual indemnification provision will it be deemed to cover fee shifting–as compared to governing documents of a company or “constitutive business entity documents”, such as an LLC agreement, that provide for advancement and indemnification provisions.  See Slip op. at 11 to 13.

In this matter, which was also the subject of many other Chancery decisions, some of which have been highlighted on these pages, the court observed that over eight years of hotly contested litigation the parties incurred collectively about $60 million in legal fees.

Over $122 million in damages was sought, but the plaintiffs were only awarded about $212,000.

The court provides sound reasoning to explain why there was no clear victor in this litigation and for those and related reasons, the court declined to award fees to either party.

Editor’s note: There is no typo in the name of the defendant above. The correct designation for the defendant entity is: LLLP.

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 Court of Chancery recently ruled that the President/CEO of Skyline Energy Renewables LLC’s parent could not wield that holding company’s power to oust a rival Skyline director because it was not his specifically delegated governance power under the operating agreements of three related limited liability energy companies’ in Roccia et al. v. Mugica, et al., No. 2020-0641-MTZ order granting motion, (Del. Ch. Dec. 29, 2020).

Vice Chancellor Morgan Zurn’s Dec. 29 summary judgment ruling sided with plaintiff Lorenzo Roccia, Skyline’s Chairman of the board and the head of Transatlantic Ultiner LLC, one of two equal managing members of Skyline’s owner, Transatlantic Group Partners LLC.  He successfully argued that his removal was void because CEO Martin Mugica, his counterpart as head of TGP’s other controlling member, Ultiner LLC, lacked authority to act on behalf of the holding company, Transatlantic Power Holdings LLC.

Background
According to the opinion, after Mugica in May 2020 notified the Skyline board that he was using his authority to remove Roccia, Roccia in July filed suit seeking an injunction barring Mugica’s removal action.

In deciding dueling summary judgment motions Vice Chancellor Zurn said it is clear that the holding company had the power to remove a director of one of the nested companies but there was no language in the agreements that enabled a top officer like Mugica to use that power on the company’s behalf.

Even though LLC’s have the freedom to generally set rights and responsibilities by contract rather than statute like traditional corporations, when LLC’s do not specifically delegate powers to officers they act through a board of directors, the court said.

“Holdings could delegate to Mugica any or all of the powers and duties to manage and control its business and affairs,” the opinion said. “As it happened, Holdings granted plenary power to its board, and only limited authority to Mugica, as president and CEO, analogized to the authority held by a corporate officer in the same position,”

Four arguments rejected
The vice chancellor rejected each of the four categories of board-granted powers that Mugica claimed gave him removal authority power:

(1) “The general powers of management usually are typically vested in the office of president of a corporation.” Removing a director of an affiliated company is neither “usual and ordinary” nor part of Holdings’ core business and “Doing so is inherently an extraordinary event, outside of Holdings’ ordinary business,” Vice Chancellor Zurn ruled.
(2) Control of Holdings’ “business and operations.”  In Miramar Police Officers Retirement Plan v. Murdoch, this Court interpreted the meaning of the term “business and operations.” Miramar Police Officers’ Ret. Plan v. Murdoch, 2015 WL 1593745, at *12–13 (Del. Ch. Apr. 7, 2015).  The Murdoch Court, relying on “commonly used dictionaries,” found that “the word ‘business’ means the commercial enterprise of a company, and the word ‘operations’ means the commercial activities of a company,” she said, distinguishing these commercial activities from “corporate governance matters.”
(3) Control over Holdings’ “officers and employees.”  Because Holdings’ designees on the Skyline Board are not officers or employees of Holdings, that branch of Mugica’s power does not reach them, she ruled.
(4) “Other duties as assigned by the Holdings Board.” There is no evidence that the Holdings Board otherwise delegated to Mugica authority by which he could exercise the company’s removal power, the vice chancellor said, because the ten enumerated restrictions the board placed on Mugica’s power were not a comprehensive list of limits.  “This language does not broaden Mugica’s authority,” the vice chancellor ruled in ordering summary judgment for the plaintiff.

A recent Delaware Court of Chancery decision granted a motion to dismiss a fiduciary duty claim that it found to be duplicative of a breach of contract claim.  In re: WeWork Litigation, Cons. C.A. No. 2020-0258-AGB (Del. Ch. Dec. 14, 2020).  Note that two decisions in this case on two separate motions were issued the same day.  Careful readers will note that the preceding hyperlink to the Slip Opinion should not be confused with the second decision published in the same case on the same day, nor should it be confused with multiple prior decisions in this same case such as one of about six weeks ago.  See In re: WeWork Litigation, 2020 WL 6375438 (Del. Ch. Oct. 30, 2020).

 

There are not as many decisions as one might expect on the topic of: when tandem claims for breach of contract and breach of fiduciary duty may proceed in the same case.  For that reason, this decision is noteworthy, although it in some ways piggybacks on the decision addressing the same issue of about six weeks ago in the same case which included a more comprehensive analysis of the issue.  See In re: WeWork, 2020 WL 6375438, at * 11-14.  In fact, the instant decision not only refers back to the Oct. 30, 2020 opinion but also incorporates it by reference.

 

In sum, this decision explains why the fiduciary duty claims cannot proceed, in part, because: (1) the complaint “does not identify any additional facts relevant to his fiduciary duty claim, but not his contract claim”; and (2) “no independent basis exists to maintain the claim for breach of fiduciary duty.”  Slip op. at 42 (citing WeWork, 2020 WL 6375438, at *14).

 

This decision also has a useful discussion of standing.  A plaintiff bears the burden of establishing standing as part of subject matter jurisdiction which includes “injury in fact.”  This requirement is often satisfied when a party to a contract is seeking to enforce it.  In this case, the court found standing to exist even “without financial loss” because the plaintiff could still conceivably be injured. See Slip op. at 14-23

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 ruled that Stimwave Technologies Inc. need not advance legal costs for its suit against its ex-CEO because she apparently doctored her indemnification agreement to falsely pre-date a charter amendment requiring officers to get a major investor group’s approval of their advancement rights in Perryman et al. v. Stimwave Technologies Inc., No. 2020-0079-SG, memorandum opinion issued (Del. Ch. Dec. 9, 2020).

Vice Chancellor Sam Glasscock’s December 9 opinion declined to order advancement for ex-CEO Laura Perryman based on his credibility issues with her testimony and documents, but he endorsed the advancement rights of her husband, director Garry Perryman, whom he found likely lacked skill to manipulate the truth or the metadata that identified his indemnification agreement.

The decision turned on the novel issue of whether the ex-CEO and director had complied with an STI charter change that purportedly gave investors in the company’s Series D Preferred stock, voting as a separate stock class, power to nullify a director or officer’s transactions, including indemnification pacts and advancement for their actions.

“Neither the bylaws nor the charter precludes the company from granting to an investor a veto right over extension of advancement benefits to its directors and officers,” the vice chancellor ruled.  Therefore, “whether Laura’s IA is valid accordingly turns on when that document was executed, which in turn determines whether such document required approval from the Series D stockholders to be valid.”

Background

Laura Perryman was a founder and CE0 of the Tucson-based marketer of wireless micro size injectable medical devices from when it was chartered in Delaware in 2010 until November 2019 when she was asked to step down amid a Department of Justice investigation.

According to the opinion, Laura sent the STI board an email the next day with an attachment that she identified as her indemnification agreement dated January 1, 2018 and based on that document, the board agreed to pay for her attorney bills for the investigation.

But the next month, STI filed its own complaint against its ex-CEO claiming she breached her fiduciary duties by directing employees to alter bills to falsely make it appear they had been paid and later added a charge that she misused company funds to pay her son’s apartment rent and bonuses to favored employees.

STI also included in the complaint what the vice chancellor found to be a “weak allegation” of breach of duty against Gary for “acting in concert” with his wife.

At a December 20 board meeting, a majority of the board concluded that the January 1, 2018 IA Laura submitted was not valid because it was actually created on November 11, 2019 —“after the DoJ’s civil investigative demand,” the opinion said.

The advancement action

Laura and Gary filed a February complaint and a petition for judgment on the pleadings to compel STI to provide indemnification and advancement.  In opposition, STI argued that both of them filed their indemnification agreements after the 2018 charter change that required Series D stockholder approval but doctored the documents to make it appear that they were signed before the amendment, so they were void ab initio under that amendment.

Gary’s advancement right

As to Gary’s right to advancement, Vice Chancellor Glasscock noted that Gary was not an executive and thus did not need to get Series D approval.  He found that even though the indemnification agreement that Gary submitted carried a date that did not jibe with his testimony, Gary had no motive for deception and was not very “engaged” in the discovery process or his role as a director.

The court found it most likely that Gary’s original IA was created before the amendment and is therefore valid.

Laura’s advancement right

STI’s document experts claimed they discovered Laura had merged her indemnification agreement with an earlier signature page and purported that its identification metadata applied to the agreement, but they said in truth, there was no metadata for her false agreement.

Vice Chancellor Glasscock found that Laura:

Has indemnification rights under the Charter, “but those may prove pyrrhic absent [advancement] funds to vindicate her legal rights”

Whether she was or was not a CEO when she signed her agreement, could not have a valid agreement if she lacked proof that it was signed before Stimwave’s July 17, 2018 charter amendment requiring Series D investor approval of benefit extension – which she did not seek.

Cannot argue that other parts of the charter always require indemnification and advancement.

“Came across as someone who had created a story to fit the facts, adjusted it as it became apparent that it would be advantageous to do so, and who was attempting to buttress that story by concocting details.”

Has failed to successfully challenge the contractual right of the company to give the Series D shareholders veto power over the extension of advancement

A time-will-tell-take-away?

Could the opinion be seen as diverging from a long trend of Chancery Court decisions that have cast a skeptical eye on any firm’s attempt to add disqualifying conditions to the indemnification/advancement rights its charter had granted?  Might the opinion encourage corporate law specialists to research more ways to attract investor groups by offering them expanded power to control executive transactions?  And might the Chancery Court of the future be asked to rule on a new species of advancement disputes as a result?

 

 

A recent decision from the Delaware Supreme Court provides hope to stockholders who seek to obtain corporate documents pursuant to Section 220 of the Delaware General Corporation Law to the extent that Delaware’s High Court removed two common defenses that companies use to oppose the production of corporate records to stockholders.  In AmerisourceBergen Corporation v. Lebanon County Employees Retirement Fund, No. 60, 2020 (Del. Supr. Dec. 10, 2020), the two most important aspects of the ruling are that:

(i) A stockholder making a Section 220 demand need not demonstrate that the wrongdoing being investigated is “actionable;” and

(ii) When the purpose of a Section 220 demand is to investigate potential wrongdoing and mismanagement, the stockholder is not required to “specify the ends to which it might use” the corporate records requested (i.e., exactly what it will do with the documents it receives).

Regular readers of these pages know that over the last 15 years I have highlighted many of the frustrating aspects of decisions construing Section 220 to the extent that one needs stamina and economic fortitude to pursue what oftentimes is an unsatisfying result.  See, e.g., my recent overview on this topic.

 

This decision should be in the toolbox of every corporate litigator not only because it announces a new path for Section 220 cases, and reminds us of the basic prerequisites of the statute, but also in light of it partially overruling and distinguishing some prior cases. This opinion also confirms that several Chancery decisions that were not in harmony with this decision should no longer be followed.

 

Key Takeaways:

•           One of the most important takeaways from this decision is that the court clarified that when the purpose of a Section 220 demand is to investigate potential mismanagement, the stockholder is “not required to specify the ends to which it might use” the corporate documents requested.  See page 22.

•           The second most important takeaway from this case is the court’s holding that a stockholder pursuing a Section 220 demand need not demonstrate that the alleged wrongdoing is “actionable.”  See page 25.

•           The three prerequisites (not including the many nuances) for successfully pursuing a Section 220 demand to inspect a corporation’s books and records requires a stockholder to establish that:  (1) such stockholder is actually a stockholder; (2) such stockholder has complied with Section 220 respecting the form and manner of making demand for inspection of such documents; and (3) the inspection such stockholder seeks is for a proper purpose.  See pages 12-13.

•           The court recited the many examples of proper purposes that have been recognized to be reasonably related to the interest of the requesting stockholder.  See footnote 30 for a lengthy list, which includes “to communicate with other stockholders in order to effectuate changes in management policies.”

•           The court reiterated the well-known requirement that when the proper purpose of a stockholder making a Section 220 demand is to investigate potential mismanagement, a stockholder needs to demonstrate “a credible basis” from which the court may infer that “there is possible mismanagement that would warrant more investigation.”  See page 15.

•           Although a credible basis of wrongdoing needs to be presented by a preponderance of the evidence to pursue the proper purpose of investigating potential wrongdoing, a company will not be permitted to mount a merits-based defense of such potential wrongdoing.  See page 37.

•           Moreover, while trying to harmonize prior decisions on these nuances, the court observed that some of the decisions struck a discordant note.  See footnote 109.

•           The court also affirmed the following two aspects of the Court of Chancery’s ruling:  (1) regarding the scope of documents, the court found that it was appropriate to include a requirement that the company produce officer-level materials and (2) the high court found it was not an abuse of discretion to order a Rule 30(b)(6) deposition–because the company refused to describe the types and custodians of corporate records that it had in response to discovery requests.  See pages 39 and 43.