Chancery Finds Breach of Obligation to Use “Diligent Efforts”

A recent Delaware Court of Chancery opinion is useful for commercial litigators who encounter the frequent situation where one party is required to use some variation on the standard of “best efforts” to either sell a product or reach certain revenue milestones, for example, in connection with a joint venture or a post-closing earn-out. In BTG International, Inc. v. Wellstat Therapeutics Corporation, C.A. No. 12562-VCL (Del. Ch. Sept. 19, 2017), the court applied the contractually defined standard of “diligent efforts” to the promotion of a pharmaceutical product, in a post-trial opinion.  This discussion of the contractually defined standard of diligent efforts is at least generally analogous to other cases highlighted on these pages that address the standard of “reasonable best efforts” or “commercially best efforts” or the like, to perform certain tasks or to reach certain goals.  Due to the relative paucity of cases thoroughly analyzing these types of standards, this case will likely be useful to many readers.

Background: This case involved a distribution agreement between two pharmaceutical companies. BTG was the larger company and agreed to promote, distribute and sell a drug called Vistogard, that the smaller Wellstat did not have the resources to promote, distribute and sell.  After extensive negotiations, the parties agreed to a contractual definition of “diligent efforts” which BTG was required to employ in order to reach various sales goals for Vistogard.  In addition, the parties were required to work together to formulate and finalize a business plan that would describe the details for promoting, distributing and selling Vistogard.

Key Findings: The court found that BTG failed to hire a sufficient number of sales representatives and failed to devote other resources to sell Vistogard, but instead focused most of its efforts and resources on a completely different product in a different division of the company – – with instructions from the CEO to keep the costs flat related to Vistogard and not to increase the resources that were necessary to implement the business plan.

The court found that BTG failed to comply with the contractually defined standard of “diligent efforts” and also breached the agreement by not complying with the business plan that required certain resources, including a sufficient number of sales representatives, to be devoted to the sale of Vistogard.

Legal Analysis: The court provides a useful discussion of the elements of a claim for breach of contract and for awarding damages. The court also took the rare step of shifting fees due to bad faith litigation tactics, and explained its reason for doing so.

The court recited the familiar elements for breach of contract: (1) the existence of a contract, whether expressed or implied; (2) the breach of an obligation imposed by that contract; and (3) the resultant damage to the plaintiff.

BTG took the aggressive approach of filing a declaratory judgment action seeking a declaration that it had not breached the contract. In response, Wellstat asserted a counterclaim for breach of contract. In sum, the court treated the DJ action as a defensive tactic, which failed, in part because Wellstat did not breach the agreement such that it would have excused a performance of BTG.

This 60-page decision provides extensive detailed factual background which is necessary to fully appreciate the court’s thorough analysis. For purposes of this relatively short overview however, the key points in the analysis are based on the court’s finding that BTG failed to devote the necessary resources for Vistogard – – and instead prioritized the sale and promotion of other products of BTG other than Vistogard.  In addition to failing to comply with the contractual definition of diligent efforts, BTG also breached the agreement by failing to comply with the business plan that required a minimum amount of resources to be devoted to the sale and promotion of Vistogard.

The court also discussed principles applicable to claims for breach of contract damages. The basic remedy for breach of contract should give the non-breaching party “the benefit of its bargain by putting the party in the position it would have been but for the breach.” See footnote 170.  Expectation damages require the breaching party to compensate for the reasonable expectation of the value of the breached contract.  These damages are to be measured “as of the time of the breach.” See footnote 172.

Although expectation damages should not act as a windfall, the “injured party need not establish the amount of damages with precise certainty when a wrong has been proven and injury established. Doubts about the extent of damages are generally resolved against the breaching party.” See footnotes 173 through 175.

Moreover the court noted that: “Public policy has led Delaware courts to show a general willingness to make a wrongdoer bear the risk of uncertainty of a damages calculation where the calculation cannot be mathematically proven.” See footnote 175.

The court concluded by taking the unusual step of shifting fees due to bad faith litigation conduct, which included the need during the litigation for Wellstat to file a motion to compel before BTG complied with its discovery obligations, as well as BTG presenting a misleading demonstrative exhibit at trial. See footnotes 216 through 218.

Chancery Orders Incorporation Provision in Books and Records Request

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

The Delaware Court of Chancery recently granted a defendant’s request to impose an incorporation provision upon a decision to grant a books and records request. That provision would deem all documents produced as incorporated by reference in any Complaint subsequently filed for purposes of a motion to dismiss. In City of Cambridge Retirement System v. Universal Health Services, Inc., C.A. No. 2017-0322-SG (Del. Ch. Oct. 12, 2017), Vice Chancellor Glasscock concluded that the provision was permitted under Section 220, and granted the defendant’s request.  Other cases have held similarly.

Background: Plaintiff, a stockholder in the defendant corporation, filed a Section 220 Complaint seeking books and records to investigate Buzzfeed’s reports that defendant lured patients into their facilities under false pretenses and exhausted their insurance benefits with unnecessary mental health treatments.  Plaintiff stated in its books and records request that it was exploring potential breach of fiduciary duties by the defendant’s board of directors, and whether pre-suit demand was required.

Plaintiff proposed a confidentiality agreement with respect to all records produced by defendant. Defendant responded with a separate confidentiality agreement, which included the incorporation provision.  Plaintiff refused to agree to the incorporation provision, and the parties submitted the incorporation issue to the Court to decide.

Analysis: The Court observed that it has broad authority under Section 220 to impose conditions on the grant of a books and records request.  The Court also noted that Section 220 seeks to balance the competing interests of stockholders to obtain information about alleged corporate mismanagement with the directors’ interest in managing the corporation without undue influence from the stockholders.

Plaintiff opposed the requested incorporation provision on the grounds that it would potentially impede its right to be the master of its own complaint in the event the request led to the filing of a complaint. Defendant argued in favor of the incorporation provision by noting that it would prevent plaintiff from cherry-picking documents and presenting them out of context, and avoiding defeat at the motion to dismiss stage.

The Court granted defendant’s request for the incorporation provision holding that it “is directed to the salutary ends of judicial and litigants’ economy.” In addition to avoiding an anti-contextual record for motion to dismiss purposes, the Court found that an incorporation provision affords it an “alternative remedy” to a Rule 11 sanction for the selective misuse of documents by a plaintiff.  Moreover, the Court also explained that motions to dismiss would remain on a “plaintiff friendly” basis despite the incorporation provision.

Take away: The Court of Chancery continues to grant requests for incorporation provisions as a condition to allowing books and records requests, as a means of forcing a plaintiff to make sure any subsequently filed complaint benefits from the use of Section 220, and that the court has the benefit of all those documents if a motion to dismiss is filed against a later complaint.

Chancery Finds Pre-Suit Demand Not Excused and Rejects “Regular Folks” Argument of Director Interestedness

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

The Delaware Court of Chancery recently dismissed a complaint for failure to adequately allege demand futility despite allegations that non-wealthy, “regular folks” directors were not disinterested based on their substantial directors’ fees. In Chester County Employees’ Retirement Fund v. New Residential Investment Corp., C.A. No.  11058-VCMR (Del. Ch. Oct. 6, 2017), Vice Chancellor Montgomery-Reeves reviewed a motion to dismiss a derivative complaint based on plaintiff’s failure to demonstrate pre-suit demand futility.

Background: Plaintiff, a stockholder in New Residential Corp. (“New Residential”) asserted direct and derivative breach of fiduciary duty claims against New Residential’s board of directors, and various other entities which allegedly exerted control over New Residential.  Plaintiff asserted in its complaint that defendants caused New Residential to overpay for assets, in exchange for substantial financial benefits conferred upon the defendants, in connection with an acquisition agreement for shares and assets of HLSS.

Defendants moved to dismiss the complaint for failure to state claims for which relief may be granted, and for failure to adequately allege demand futility. Defendants contended, among other things, that a majority of New Residential’s board “is disinterested and independent,” and not beholden to its co-defendant.

Analysis: The Court noted the familiar pleading requirement under Rule 23.1 that a derivative plaintiff who has not made a pre-suit demand upon the corporation’s board of directors must allege with particularized facts showing that demand would have been futile.  The Court applied the two-prong Aronson test, which requires the plaintiff to establish either that: (1) a majority of the directors are interested in the transaction, or (2) the challenged transaction was not the exercise of valid business judgment.

Vice Chancellor Montgomery-Reeves noted that New Residential has in its charter a Section 102(b)(7) exculpation provision that insulates directors from liability for breaches of their duty of care. Accordingly, to establish demand futility, plaintiff would need to demonstrate that a majority of the board was interested due to director liability for non-exculpatory claims, such as for breach of the duty of loyalty.

Plaintiff alleged director interestedness based on indemnification and exculpation benefits, the receipt of directors’ fees by a director who serves as a municipal employee and “has not accumulated great wealth,” a retired director who receives fees, and multiple directors who share “several years of social connections” and common charitable interests.

The Court concluded that Aronson’s first prong was not met because plaintiff failed to raise a reasonable doubt with respect to the interestedness of a majority of the board of directors.  In so holding, the Court refused to adopt “a blanket determination that all retired board members lack independence.”  Moreover, the Court refused to find as a general rule that “regular folks” who toil at routine day jobs are interested in corporate decisions by virtue of their director’s fees.  The Court found that such a rule would discourage membership on corporate boards among the non-wealthy.

Lastly, the Court found that plaintiff failed to meet the second prong of Aronson because the allegations did not go “so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.”  Accordingly, the Court found that the business judgment rule presumption was not overcome, and the directors accordingly did not face a ‘substantial likelihood of director liability.”

Takeaway: The Court of Chancery refuses to infer, in the absence of additional particularized facts, that individuals of modest incomes and retirees serving on corporate boards are interested in corporate derivative litigation decisions solely by virtue of the receipt of directors’ fees.

Chancery Excuses Pre-Suit Demand Requirement Due to Board’s Knowing Violation of Federal Regulation

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

The Delaware Court of Chancery denied a motion to dismiss two claims in a derivative action, finding pre-suit demand futility was established because the allegations of knowing violation of a federal regulation by the defendant directors sufficiently alleged bad faith conduct. In Kandell v. Niv, C.A. No. 11812-VCG (Del. Ch. Sept. 29, 2017), plaintiff, a stockholder of FXCM, Inc., brought a derivative claim against the directors of FXCM for their alleged mismanagement of the corporation and a drastic decline in its valuation.  More specifically, the plaintiff alleged that the directors embraced a business model premised on pervasive violation of a federal regulation of the Commodity Futures Trading Commission (“CFTC”).

Background: FXCM is an online foreign currency exchange platform that affords its retail and institutional customers the opportunity to engage in often highly leveraged speculative and hedging transactions.  FXCM touted to potential customers that they would not be held accountable for any losses in excess of the amounts invested.  This promise directly violated a regulation of the CFTC, which prohibited an entity under CFTC jurisdiction from guaranteeing customers immunity from losses in excess of their cash investment.

FXCM experienced substantial losses as a result of the foreign currency exchange “Flash Crash” of early 2015. FXCM’s losses led to its need to accept a loan with onerous terms in order to survive as a going concern.

The plaintiff filed a derivative action in Chancery asserting that the defendant FXCM directors breached their fiduciary duties, committed waste with respect to corporate assets, and unjustly enriched themselves. The plaintiff did not make a pre-suit demand upon the board of directors, and asserted that such demand would be futile.  The defendants moved to dismiss the complaint on the grounds that demand should not be excused under the Rales test.

Analysis: The Court noted that the Rales test applied to the challenged transactions at issue.  Under the familiar Rales test, a plaintiff must allege particularized facts to establish a reasonable doubt that the board could have exercised its independent and disinterested business judgment if the plaintiff had made a demand.

The plaintiff argued that demand would have been futile because the board pursued a business model in direct contravention of a federal regulation. The plaintiff did not assert that the directors were interested in or lacked independence with respect to the acts in violation of the CFTC regulation, but instead asserted that the directors “face[d] a substantial likelihood of liability because they violated the duty of loyalty by allowing or causing the Company to become a lawbreaker.”

The Court noted that “[w]here directors intentionally cause their corporation to violate positive law, they act in bad faith; this state does not ‘charter lawbreakers.’” The Court went on to hold that the allegations sufficiently demonstrated the threat of personal liability for the directors, and therefore rendered them incapable of disinterestedly evaluating a litigation demand.  Accordingly, the Court ruled that pre-suit demand was excused with respect to the claims premised on violation of the CFTC regulation.

Take away: Recognizing the unusual facts before the Court, Vice Chancellor Glasscock noted that “I pause to emphasize that this case presents a highly unusual set of facts: a Delaware corporation with a business model allegedly reliant on a clear violation of a federal regulation; a situation of which I can reasonably infer the Board was aware.”

Chancery Rules on Stock Transfer Restrictions

In my latest column for the National Association of Corporate Directors’ publication called Directorship, I provide an overview of a recent opinion from the Delaware Court of Chancery which examined the nuances of stock transfer restrictions. I previously highlighted the decision in Henry v. Phixios Holdings, Inc. on these pages.

Chancery Refuses to Seal Courtroom for Allegedly Confidential Trial Exhibits

The Court of Chancery recently rejected a request by a non-party to seal certain trial exhibits so that they would not become part of the public trial record.  The court also rejected a request to close the courtroom to the public during trial for any testimony or argument regarding those exhibits.  ADT Holdings, Inc. v. Harris, C.A. No. 2017-03218-JTL (Del. Ch. Sept. 28, 2017).

Court’s Reasoning: The court explained that Court of Chancery Rule 5.1, which provides for designating certain filings with the court as confidential if various criteria are satisfied, reflects a commitment of the court to maintaining public access to its proceedings–with limited exceptions. The opinion provided copious citations to various authorities supporting the well-settled presumption that court proceedings are open to the public, based on multiple public policy reasons.

The court reviewed the documents that the movant requested confidential treatment for, and found that they were in large measure “form” documents, as opposed to customized documents, that did not contain any information that would disadvantage the moving party in its future negotiations.  The court was not convinced that any of the documents contained information that would create a risk of economic disadvantage with respect to competitors and others in the industry.

In essence, the court found that the allegations of harm from public disclosure were conclusory and not sufficiently buttressed by details or convincing facts.

For example, the court reasoned that there was no credible basis to believe that the arm’s-length relationship between the persons seeking confidential treatment and the other parties to the agreement, were so “highly sensitive such that its disclosure would cause competitive harm.”  Moreover, the court found that the relationship between the parties to the agreements at issue and the terms of those agreements were important facts necessary for a resolution of the case, and thus could not be withheld justifiably from the public.

Takeaway: A high threshold must be met, even by non-parties, in order to keep from the public the documents that become part of a lawsuit, either prior to trial or during trial.

Chancery Reviews Fiduciary Duties of Independent Board of Directors

A recent Delaware Court of Chancery decision addressed how the court will review claims against an independent and disinterested board for breach of the duty of loyalty in connection with a merger transaction. The opinion styled Kahn v. Stern, C.A. No. 12498-VCG (Del. Ch. Aug. 28, 2017), involved allegations made unsuccessfully, that the board of directors breached their duties as a result of side deals that allegedly were made in connection with a merger that personally benefited the directors in an inappropriate manner.  Allegations were also made unsuccessfully that insufficient information was provided to stockholders before a majority approved the merger by written consent.

The detailed facts are essential for a complete understanding of the decision by the court, however, for purposes of this short blog post a focus on the court’s analysis and its application of the legal principles involved has the most widespread usefulness.

A critical determination was the court’s finding that three of the five board members were considered independent and disinterested. That determination by the court impacted the standard of review that the court applied.

The court began its legal analysis with a review of the requirements that a complaint must satisfy in order to prevail on a motion to dismiss, which was the procedural posture in which the decision in this case was made. In particular, where, as here, there was no controlling or majority stockholder, and the court found that three out of the five directors were considered independent, the complaint was required to include “sufficient facts to show that a majority of the board of directors breached the fiduciary duty of loyalty.”

That is, because the court found that a majority of the board was not dominated or controlled by an interested party, the board enjoyed the presumptions of the business judgment rule.  Generally, under the business judgment rule, the court will not second-guess well-informed, independent and disinterested board decisions.  Notably, there was no enhanced scrutiny applicable because no Revlon claim was made that the board did not attempt to obtain the highest possible price for the company.

There was no issue whether two of the five directors were considered independent and disinterested. The determining factor was whether the third director, Joseph Daly, could be so described.

In the court’s analysis to determine whether Daly was “disinterested,” which would have resulted in a majority of the board not being disinterested, the court observed that the sole allegation regarding Daly was that he had a large, illiquid block of shares, and that he aligned himself with another stockholder that was supporting the sale of the company, and that Daly was excluded from the special committee.  Daly owned approximately 19.1% of the company, making him the largest single stockholder.  There is no allegation that Daly received different or unique consideration.  Nor does the complaint allege that he faced a liquidity crisis or an urgent need to sell his stock.  The complaint failed to plead a disabling interest of Daly because his incentives were the same as that of other stockholders:  to maximize the value of his interests.

The next issue was whether Daly was an independent director. The court explained that to plead a lack of independence, a plaintiff must plead facts that, if true, overcome the presumption of a director’s faithfulness to his fiduciary duties.  There was no detail in the complaint to support the conclusion that Daly was unable to “objectively make a business decision” concerning the merger.

The court reasoned that in the face of a majority of disinterested and independent board members, and an exculpatory charter provision, in order to survive a motion to dismiss and pursue a post-closing damages claim for breach of fiduciary duty, the plaintiff was required to plead facts making it “reasonably conceivable that a majority of a board acted in bad faith.”

Bad faith will be found if a “fiduciary intentionally fails to act in the face of a known duty to act, demonstrating a conscious disregard for his duties.”  Bad faith may also be found when “the decision under attack is so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.”

The allegations that the board members approved the merger without knowledge of the side deals and that there were omissions and misstatements in the information provided to stockholders, was insufficient to establish bad faith.  The court reasoned that the complaint did not plead facts that created a reasonable inference of bad faith because the amount of the reduction in the merger price allegedly based on the side deals was never described in detail; more importantly, details to negate the good faith of the independent directors who approved the merger in light of the side deals was absent from the complaint.

The court found that there were insufficient facts in the complaint to support the allegations that the actions of the board members were made without the best interest of the corporation in mind, and there were also insufficient facts to support the argument that it was “reasonably conceivable that the board took action inexplicable on grounds other than bad faith.”

Regarding the disclosure omissions and misstatements, the court observed that if the issues were presented in a pre-closing request for injunctive relief, the court would have employed enhanced scrutiny to review the disclosure allegations, not to determine damages. In a pre-closing procedural context, unlike in the current procedural posture, if appropriate, the court would afford equitable relief in aid of a stockholder pursuing statutory voting or appraisal rights.

By contrast, in this post-closing request for damages, the focus is on whether the directors of the acquired entity are conceivably liable for damages based on a non-exculpated breach of fiduciary duty due to the alleged failure to make material disclosures. Specifically, that would require the plaintiff to point to facts in the complaint to support an inference that the board acted in bad faith in issuing the disclosures, implicating the duty of loyalty – – as opposed to a mere erroneous judgment in the failure to make a disclosure which would implicate the duty of care which in this instance is exculpated by a provision in the charter.

The court explained that in a post-closing claim for damages, information deficiencies that might be found material in support of a claim for injunctive relief pre-closing, may be insufficient to support a claim for damages where, as here, nothing in the record created an inference that the directors deliberately withhold information or disregarded a manifest duty.

Court of Chancery Jurist Co-Authors Article on Drafting

Vice Chancellor J. Travis Laster of the Delaware Court of Chancery co-authored with Ken Adams, an article about agreements that attempt to preempt judicial discretion.  Copious footnotes to court decisions and treatises support the helpful analysis and drafting tips provided. The article should be required reading for anyone litigating the meaning of an agreement in the Delaware Court of Chancery–or drafting any document that might be the subject of corporate or commercial litigation in the Delaware Court of Chancery.

Court Enforces Post-Mediation Settlement Terms

A recent letter ruling is useful for commercial litigators for two contract interpretation principles that the Court of Chancery addresses in a business-like manner. In Frank Robino III v. Paul Robino; Charles Robino, et al. (Del. Ch. Aug. 16, 2017), the Court addressed:

(1)        What standard is applied when a person claims that an agreement is not binding due to duress and/or allegations of diminished capacity as a result of substance abuse, including intoxication;

(2)        When a settlement agreement reached during mediation that might not have all the complete formality and comprehensiveness of a typical agreement, can still be enforceable.


The procedural context of this case was a motion to enforce a settlement agreement that was reached after mediation. Both parties were represented by competent counsel during the mediation, and the court describes the mediator as one of the most experienced mediators in Delaware.  The court granted the motion to enforce a settlement agreement and rejected the two defenses presented.

Rejected Defenses

The first rejected defense was based on the asserted argument of duress as well as substance abuse that apparently included intoxication or inebriation. The court cited to Delaware case law explaining the burden of proof and the challenges in prevailing on such a defense, which was not successful in this case.

Key Holding

Regarding the mediation that resulted in a settlement agreement, the court found that the essential terms of the agreement were agreed to, in a signed document at the mediation. It was not clear whether a more formal and comprehensive agreement was contemplated, although the parties did attempt unsuccessfully to negotiate a more formal and comprehensive agreement after the mediation.  Nonetheless, the court found that the terms that were agreed to and signed at the mediation were sufficient to enforce it as a binding contract.

Court Rejects Post-Closing Adjustment Claims

The Delaware Court of Chancery recently addressed a common type of claim in commercial litigation: Post-closing adjustments to the purchase price. Sparton Corporation v. O’Neil, C.A. No. 12403-VCMR (Del. Ch. Aug. 9, 2017).

Basic Facts: The claims in this case involved an assertion that the defendant directors changed the selling company’s accounts receivable after an amount was determined for an escrow account for post-closing adjustments–but the change was made prior to the closing, unbeknownst to the buyers. In essence, the court found that the allegations of fraud did not satisfy the prerequisites for specificity, and, in addition, a robust anti-reliance clause prevented claims based on representations outside the contract.

Key Takeaways

Anti-Reliance Provision and Fraud Claims

The most noteworthy statement of law from this decision, that has the most widespread application, is based on the strong anti-reliance provision in the agreement, and settled Delaware law that prevented claims based on misrepresentations outside the four corners of the agreement. The anti-reliance clause was quoted at length in the opinion and was very specific to the extent that the parties agreed that the sole and exclusive representations were those contained in the  agreement and that no representations outside the agreement were relied upon in connection with the purchase. (See footnote 44 which cited to the well-known Abry case on which the court’s reasoning was based.)

In addition, the court relied on the basic pleading prerequisites for fraud which require much more specificity than non-fraud claims require. In addition, the court distinguished the Osram case which noted that “a mere allegation that a defendant knew or should have known about a false statement is not sufficient to plead the requisite state of mind” for fraud.The court reasoned that in this case, none of the defendants personally represented the accuracy of the financial statements, and that they were not a position to know the veracity of the statements. Also, the plaintiff did not plead any particularized facts about the roles of the defendant in the company or the relationships of the defendants with management. Nor did the plaintiffs allege any facts to show that the defendants would be a position to know that the documents were falsely prepared.

Commercially Reasonable Efforts

Also noteworthy is the court’s treatment of a claim that “commercially reasonable efforts,” as required by the agreement, were not employed. The case law on the “commercially reasonable efforts standard” has been written about on these pages in connection with recent decisions, but because case law about that contractual standard is not fully evolved, I mention it here in passing even though the court’s discussion is not comprehensive. See Slip op. at page 15.The allegation was that it should have been self-evident that because certain actions did not take place by a certain deadline in the agreement, that the reason must have been the lack of an exercise of commercially reasonable efforts. The court rejected this conclusory allegation because it was not self-sufficient and did not satisfy the “reasonably conceivable test” under Rule 12(b)(6).