A recent Delaware decision addressed the request for a claw-back of legal expenses that a company was ordered to advance to an LLC manager in a prior Court of Chancery decision. In the case styled: New Wood Resources, LLC v. Baldwin, C.A. No. N20C-10-231-AML-CCLD, Order (Del. Super. Aug. 23, 2021), the Complex Commercial Litigation Division of the Delaware Superior Court determined that pursuant to the terms of an LLC Agreement (for which the Delaware LLC Act allows much greater latitude than Section 145 of the Delaware General Corporation Law on this issue), the court determined that some of the amounts advanced were required to be returned.

Most noteworthy, however, about this decision, is that the court determined that the undertaking to repay the amounts advanced did not apply to the “fees on fees” that the Court of Chancery had also required that the company pay in the prior advancement action. The court explained that the undertaking only applied to “funds advanced,” but that undertaking did not apply to the repayment of “fees on fees” because the court reasoned that “such sums constitute indemnification, rather than advancement.” Order at 12. [Readers should be aware that in Delaware, court decisions issued by Order may also be cited in briefs, even if the decision is not a formal opinion.] See footnote 43 (judge explains that even though the parties did not raise the distinction between advancement and indemnification in connection with the claw-back arguments, the court determined that: it was “compelled by principles of comity to raise the issue sua sponte about the “fees on fees” that the Court of Chancery ordered the company to pay which should be considered differently from the advancement ordered by the court and governed by the undertaking.”)

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 refused most of B. Riley Financial, Inc.’s motion to dismiss an ex-officer and director’s complaint for indemnification for his settlement of underlying breach-of-duty and fraud charges against him and companies he had founded and later sold to Riley in Wunderlich v. B. Riley Financial, Inc., et al., No. 2020-0453-PAF (Del. Ch. March 24, 2021).

In a March 24 letter ruling, Vice Chancellor Paul Fioravanti Jr. ruled that Riley’s dismissal bid cannot rely on the limits in its interpretation of an indemnification contract plaintiff Gary Wunderlich signed as part of his companies’ 2017 merger with that financial services firm, since it is not the only reasonable reading.

In addition, Wunderlich makes a plausible argument that Riley took over his investment and securities companies’ indemnification obligations when it made them subsidiaries, and Riley had been paying Wunderlich’s legal costs until the two parted ways in Nov. 2018 and Wunderlich was hit with a $10.5 million arbitration award, the vice chancellor said. The Chancery Court let Wunderlich continue to pursue his indemnification claim but dismissed as unripe a declaratory judgment count seeking to hold Riley separately liable for any judgment in the arbitration action.

The opinion could be of value to advancement and indemnification specialists in how it employs Delaware contract law principles to determine the scope of rights and responsibilities in the various indemnification agreements.

Background
Gary Wunderlich founded Wunderlich Investment Company, Inc. and parent Wunderlich Securities, Inc. in 1996 and sold them to Riley in May 2017 but two months later investment and merchant banking firm Dominick & Dickerman LLC brought an arbitration proceeding against Wunderlich and his two companies in the Financial Industry Regulatory Authority. At the time, he was an officer and director of his companies and Riley; Riley initially took over attorney selection and payment, the vice chancellor said.

After the April 2020 award of $10.5 million jointly and severally against Wunderlich and his companies, the claimants filed a petition to confirm the award in May and Riley petitioned to vacate it the next day in the U.S. District Court for the Southern District of New York. Meanwhile, Wunderlich, in April 2020, formally demanded that B. Riley “confirm” that it would indemnify him for “all costs, expenses, awards, losses and liabilities incurred by reason of the fact that he was an officer or director” of B. Riley, WIC, and WSI.

Riley threatened to pursue claims against Wunderlich for actions relating to the Arbitration and to recover from Wunderlich amounts Defendants paid in the Settlement Agreement, and Wunderlich filed this indemnification action in June seeking indemnification from his two companies, and Riley under the merger agreement.

The suit includes claims for:
•Reasonable attorneys’ fees and other expenses incurred in connection with defending against and pursuing vacatur of the Award and negotiating the terms of the Settlement
•Wunderlich’s fees and expenses incurred in this action, or “fees-on-fees.”
•A declaratory judgment obligating Defendants to indemnify Wunderlich for any contribution claim that Defendants “may seek to assert against him in connection with the Arbitration
•B. Riley’s alleged failure to tender payment in response to Wunderlich’s indemnification demand breached the Indemnification Agreement.

Declaratory judgment on contribution
The vice chancellor said “our courts will decline ‘to enter a declaratory judgment with respect to indemnity until there is a judgment against the party seeking it.’” quoting Wal-Mart Stores, Inc. v. AIG Life Ins. Co., 572 A.2d 611, 632 (Del. Ch. 2005). He said, “Defendants have not asserted a contribution action against Wunderlich, and Wunderlich does not presently owe any amounts to be paid in connection with the Settlement Agreement.” If the defendants do not assert a contribution claim against Wunderlich “judicial intervention may be unnecessary.”

Breach of the Indemnification Agreement
“Defendants principally argue that Wunderlich waived his indemnity rights when he executed the Severance Agreement,” the court said. “Central to this decision is whether the indemnification provisions in the bylaws are preserved through a carve-out in the Severance Agreement, which, in turn, requires the construction of the terms of the Merger Agreement.”

But ‘[d]ismissal, pursuant to Rule 12(b)(6), is proper only if the defendants’ interpretation[s] [are] the only reasonable construction[s] as a matter of law” and that is not the case here the court said. “Wunderlich has stated a claim for indemnification…because he has advanced a reasonable interpretation of the WIC Bylaws, the Merger Agreement, and the Severance Agreement.”

Defendants rely on Julian v. Julian for the proposition that the only rights that “arise under” a contract are those that exist within its four corners,” Vice Chancellor but “Julian is factually inapposite because the relevant language in the Merger Agreement and the Severance Agreement are different from the arbitration provision at issue in Julian. Julian v. Julian, 2009 WL 2937121 (Del. Ch. Sept. 9, 2009).

He said he cannot determine as a matter of law that the Severance Agreement only released the indemnification rights listed in the Merger Agreement to the exclusion of any indemnification rights but he doesn’t need to at this stage.

Fees on Fees
Wunderlich’s claim for fees-on-fees in enforcing his indemnification rights, need not be dismissed just because he has not identified any applicable indemnification provisions, the court said, because under Section 145 of the DGCL, “without an award of attorneys’ fees for the indemnification suit itself, indemnification would be incomplete” and Wunderlich’s indemnification requires WIC to provide indemnification “to the fullest extent permitted by the Delaware General Corporation Law”.

A recent letter ruling from the Court of Chancery on a nuance of the law of advancement deserves to be remembered. The Court’s decision in Day v. Diligence, Inc., C.A. No. 2020-0076-SG (Del. Ch. May 7, 2020), is short but important due to its clarification of a finer point regarding the duty of a company to advance fees prior to the date of the undertaking required under DGCL Section 145(e).  The Court reasoned that an advancement obligation may cover fees incurred prior to the receipt of a requisite undertaking.

The multitude of highlights of advancement decisions that have appeared on these pages over the last 15 years provide extensive details about the intricacies of Section 145(e), as do the several book chapters I have written on the topic. This cursory post assumes a basic understanding of the Delaware law of advancement of fees for directors and officers pursuant to Section 145(e), and based on that assumption this pithy post provides the following quote from the Day case, that should be in the toolbox of every corporate litigator.

The Court held, after reciting DGCL Section 145(e), that:

Nothing in the language of the statute, or the policy implicit therein, limits advancement to sums incurred post-undertaking, to my mind. The Defendant, I note, has pointed to none. Nor has it cited to precedent….

The following article is reprinted with permission from the Jan. 15, 2020 edition of “The Delaware Business Court Insider”, (c) 2020 ALM Media Properties, LLC. All rights reserved.

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

This is the 15th year that Francis Pileggi and various co-authors have created an annual list of important 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 2019. 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 at this hyperlink.

This 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. Links are also provided below to the actual court decisions and longer summaries.

DELAWARE SUPREME COURT DECISIONS

Company Required to Produce Emails Among Management to Stockholders

The Delaware Supreme Court recently issued an opinion that clarifies the duty of a company to produce emails among its management in a Section 220 case. In KT4 Partners LLC v. Palantir Technologies, Inc., Del. Supr., No. 281, 2018 (Jan. 29, 2019), Delaware’s high court addressed a demand under Delaware General Corporation Law (DGCL) Section 220 by a stockholder for corporate books and records, including emails and electronically-stored information (ESI) among management, to allow the stockholder to investigate possible wrongdoing, such as the reasons behind amendments to an Investors’ Rights Agreement that severely reduced the original rights granted under that agreement. This opinion quoted from a law review article co-authored by Francis Pileggi on the intersection of DGCL Section 220 and ESI.

https://www.delawarelitigation.com/2019/01/articles/delaware-supreme-court-updates/company-required-to-produce-emails-among-management-to-stockholders/

Supreme Court Explains the Implied Covenant of Good Faith and Fair Dealing

A recent Delaware Supreme Court decision is must-reading for those who need to know the latest iteration of Delaware law on the implied covenant of good faith and fair dealing. In Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, Del. Supr. No. 536, 2018 (Jan. 17, 2019), Delaware’s High Court provided the latest articulation of Delaware law on the multi-faceted doctrine of the implied covenant of good faith and fairing dealing. In connection with affirming in part and reversing in part a 176-page trial court opinion, which was highlighted on these pages, the Supreme Court agreed with the analysis of the trial court’s correct reading of the plain meaning of the LLC agreement at issue, but disagreed with the application by the trial court of the implied covenant.

 https://www.delawarelitigation.com/2019/01/articles/delaware-supreme-court-updates/supreme-court-explains-the-implied-covenant-of-good-faith-and-fair-dealing/

Delaware Supreme Court Clarifies Ab Initio Requirement for BJR Review

The Delaware Supreme Court recently clarified the “ab initio” requirement announced in Kahn v. M&F Worldwide Corp. case as part of the set of standards that would allow for the BJR standard to apply to a challenged merger. See Olenik v. Lodzinski, No. 392, 2018 (Del. Supr., rev. April 11, 2019).  The High Court determined that the requirement was not satisfied based on the facts of the instant case because the “economic bargaining took place prior to the date” when the protections announced in the Kahn v. M&F Worldwide Corp. case needed to be in place.

Much commentary has already been written about this case, so a lengthy summary is not provided here, but I refer to prior decisions that have applied the ab initio requirement, for background purposes, as noted on these pages.

 https://www.delawarelitigation.com/2019/04/articles/delaware-supreme-court-updates/delaware-supreme-court-clarifies-ab-initio-requirement-for-bjr-review/

Delaware Supreme Court Clarifies Appraisal Law

The Delaware Supreme Court, in a per curiam decision, recently determined that “deal price less synergies” was the appropriate determination of fair value in the appraisal action before it.  In Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., C.A. No. 11448-VCL (Del. Apr. 16, 2019), the Court reversed the Court of Chancery’s holding that “unaffected market price” was the fair value on the date of the merger. This case is the third in a recent trilogy of precedent-setting Delaware appraisal cases, preceded by DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017) and Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd, 177 A.3d 1 (Del. 2017).  This case has been the subject of extensive commentary by scholars and practitioners.

https://www.delawarelitigation.com/2019/04/articles/delaware-supreme-court-updates/delaware-supreme-court-clarifies-appraisal-law/

Delaware Supreme Court Addresses Independence of Directors

In Marchand v. Barnhil, CA. No. 2017-0586-JRS (Del. Ch. June 18, 2019), the Delaware Supreme Court addressed the meaning of the words “independence” and “disinterestedness” in the context of adequately pleading pre-suit demand futility as a prerequisite for pursuing a derivative claim against corporate directors. The court reversed the Court of Chancery’s dismissal of the case for failure to establish demand futility. This issue is one of the most nuanced and challenging in Delaware corporate litigation as indicated by the disagreement on the outcome among the experienced jurists deciding this case.

https://www.delawarelitigation.com/2019/06/articles/delaware-supreme-court-updates/delaware-supreme-court-addresses-independence-of-directors/

Delaware Supreme Court Instructs on Standards of Deposition Conduct

A recent Delaware Supreme Court opinion provides a tutorial on the standards imposed on Delaware lawyers when a deponent, who is the lawyer’s client, engages in inappropriate conduct during a deposition. In Shorenstein Hays-Nederland Theaters LLC Appeals, Nos. 596, 2018 and 620-2018 (Del. June 20, 2019), Delaware’s High Court issued its first decision on this specific issue, as compared to the rather abundant guidance that has existed for many years regarding the consequences when lawyers themselves engage in errant conduct during a deposition.

https://www.delawarelitigation.com/2019/09/articles/delaware-supreme-court-updates/delaware-supreme-court-instructs-on-standards-of-deposition-conduct/

Confidentiality Agreement Not Always Required for Section 220 Demands

For the first time, the Delaware Supreme Court decided that in a lawsuit in which a stockholder demands corporate books and records pursuant to Section 220 of the Delaware General Corporation Law, although it is typical to condition the production of records on entering into a confidentiality agreement, that the statute does not strictly require such a condition for production. The court also explained in Tiger v. Boast Apparel, Inc., No. 23, 2019 (Del. Aug. 7, 2019), that a party need not show exigent circumstances for a court to grant something less than indefinite confidentiality, and the inspection of records pursuant to Section 220 is not subject to a presumption of confidentiality.

https://www.delawarelitigation.com/2019/08/articles/delaware-supreme-court-updates/confidentiality-agreement-not-always-required-for-section-220-demands/

COURT OF CHANCERY DECISIONS

Chancery Clarifies Director’s Right to Corporate Records

A recent Delaware Court of Chancery decision addressed the important issue of the right of directors to be given access to corporate records. In Schnatter v. Papa John’s International, Inc., C.A. No. 2018-0542-AGB (Del. Ch. Jan. 15, 2019), Delaware’s court of equity considered a claim under Section 220(d) of the Delaware General Corporation Law (DGCL) by the founder and largest stockholder of the Papa John’s pizza chain who was forced out as the CEO but retained his position as a director.  He sought to obtain books and records in his capacity as a director to support an investigation that the other directors breached their fiduciary duties by improperly ousting him for unjustified reasons.

https://www.delawarelitigation.com/2019/01/articles/chancery-court-updates/chancery-clarifies-directors-right-to-corporate-records/

Chancery Finds Usurpation of Corporate Opportunity

Delaware case law is well-established regarding the aspect of the fiduciary duty of loyalty that prohibits a corporate director from usurping a corporate opportunity. A recent decision from the Delaware Court of Chancery applies that well-settled prohibition in a flexible manner to a set of facts that have apparently not been squarely addressed in prior precedent.  In Personal Touch Holding Corp. v. Glaubach, C.A. No. 11199-CB (Del. Ch. Feb. 25, 2019), the court awarded damages for the breach of this subset of fiduciary duty, as well as for other breaches of fiduciary duty.

https://www.delawarelitigation.com/2019/03/articles/chancery-court-updates/chancery-finds-usurpation-of-corporate-opportunity/

Chancery Applies Corporate Advancement Case Law to LLC Context

A recent Delaware Court of Chancery decision interpreted the advancement provisions of an LLC Agreement by applying case law interpreting DGCL Section 145 in the corporate context.  In Freeman Family LLC v. Park Avenue Landing LLC, C.A. No. 2018-0683-TMR (Del. Ch. Apr. 30, 2019), the court reviewed the applicability of “defined phrases” that are familiar prerequisites for advancement in the corporate context pursuant to DGCL Section 145, and analyzed that same language that was used in an LLC agreement provision granting advancement.

https://www.delawarelitigation.com/2019/05/articles/chancery-court-updates/chancery-applies-corporate-advancement-case-law-to-llc-context/

Chancery Instructs on DGCL Merger Requirements

A recent Delaware Court of Chancery opinion began by describing the complaint as reading like a law school exam designed to test the knowledge of a student regarding the requirements in the DGCL that must be satisfied in connection with a merger, and the court commented that the company would not have done well on the exam.

In Mehta v. Mobile Posse, Inc., C.A. No. 2018-0355-KSJM (Del. Ch. May 8, 2019), the court identified the six primary issues in this case as follows:

(1) Whether DGCL Section 262 was not complied with in connection with the failure to notify stockholders of their appraisal rights within the required timeframe;

(2) Whether DGCL Section 228 was not complied with due to the failure to send prompt notice of the written stockholder consents;

(3) Whether the merger agreement, or documents it incorporates, failed to comply with DGCL Section 251 by not including the amount of cash the preferred stockholders would receive for their shares;

(4) Whether the stockholder consents did not enjoy the ratifying effect under DGCL Section 144;

(5)  Whether the director defendants breached their fiduciary duty of disclosure; and

(6) Whether the director defendants breached the fiduciary duty of loyalty because the merger was a self-dealing transaction and not entirely fair.  With one small exception, the court found that the statutory violations were sufficiently established at the early procedural stage of a motion for judgment on the pleadings.

https://www.delawarelitigation.com/2019/05/articles/chancery-court-updates/chancery-instructs-on-dgcl-merger-requirements/

Chancery Grants Advancement on Counterclaims

A recent decision of the Delaware Court of Chancery clarifies those instances where a defensive counterclaim against a former officer and director may be covered by advancement rights. In a bench ruling in Dodelson v. AC Hold Co., Inc., C.A. No. 2019-009-SG (Transcript) (Del. Ch. May 21, 2019), the court interpreted the charter provision that included within the coverage for “indemnified parties” both former directors and officers. Notably, bench rulings may be cited as authority in briefs before the Delaware Court of Chancery.

https://www.delawarelitigation.com/2019/06/articles/chancery-court-updates/chancery-grants-advancement-on-counterclaims/

Chancery Orders Mandatory Indemnification per DGCL Section 145(c)

The recent Delaware Court of Chancery decision in Brown v. Rite Aid Corporation, C.A. No. 2017-0480-MTZ (Del. Ch. May 24, 2019), clarified the perennial issue of how the word “success” is defined for purposes of mandatory indemnification under Section 145(c) of the Delaware General Corporation Law–even if all of the arguments in the underlying litigation were not successful.

https://www.delawarelitigation.com/2019/06/articles/chancery-court-updates/chancery-orders-mandatory-indemnification-per-dgcl-section-145c/

Chancery Determines Valid LLC Managers; Rejects Bump-Out Theory of Board Replacements

The Delaware Court of Chancery left no doubt in a recent ruling that the “bump-out theory” of replacing LLC managers is not recognized in Delaware. In Llamas v. Titus, C.A. No. 2018-0516-JTL (Del. Ch. June 18, 2019), the court explained that incumbent managers need to be removed before their replacements can validly “take their seats.” The court interpreted the counterpart to DGCL Section 225, which is Section 18-110(a) of the Delaware LLC Act.

https://www.delawarelitigation.com/2019/07/articles/chancery-court-updates/chancery-determines-valid-llc-managers-rejects-bump-out-theory-of-board-replacements/

Advancement Granted for Post-Termination Use of Confidential Information

A recent Delaware Court of Chancery opinion in Ephrat v. medCPU, Inc., C.A. No. 2018-0052-MTZ (Del. Ch. June 26, 2019), will remain a noteworthy decision for two reasons: (1) It provides and anthology of prior Delaware decisions granting advancement to former directors or officers that defend claims regarding the use of confidential information acquired in a prior corporate capacity; and (2) It adds nuance to the existing abundant case law interpreting the threshold phrase “by reason of the fact,” which is one of the statutory prerequisites that must be satisfied for advancement claims to prevail pursuant to DGCL Section 145.

https://www.delawarelitigation.com/2019/07/articles/chancery-court-updates/advancement-granted-for-post-termination-use-of-confidential-information/

Chancery Addresses Personal Jurisdiction Over Co-Conspirator

In Clark v. Davenport, C.A. No. 2017-0839-JTL (Del. Ch. July 18, 2019), the court provided a noteworthy explanation of the important nuances that need to be understood when personal jurisdiction is contested, and this opinion provides an excellent analysis of the requirements for opposing personal jurisdiction based on the Delaware Long Arm Statute.

https://www.delawarelitigation.com/2019/08/articles/chancery-court-updates/chancery-addresses-personal-jurisdiction-over-co-conspirator/

Fully-Executed Contract Ruled Unenforceable

In Kotler v. Shipman Associates, LLC, C.A. No. 2017-0457-JRS (Del. Ch. Aug. 21, 2019), the Delaware Court of Chancery issued an opinion that should be read by all lawyers who seek to avoid the risk of a fully-executed contract being ruled unenforceable due to a court later finding, perhaps surprisingly, that the agreement did not accurately express the understanding of the parties.

https://www.delawarelitigation.com/2019/08/articles/chancery-court-updates/fully-executed-contract-ruled-unenforceable/

Chancery Explains Step-Transaction Doctrine and Defines “Affiliate”

An important concept known as the step-transaction doctrine, which treats the agreements in a series of formally separate but related transactions involving the transfer of property as a single transaction if all the steps are substantially linked, was explained in the recent Delaware Court of Chancery opinion in PWP Xerion Holdings III LLC v. Redleaf Resources, Inc., C.A. No. 2017-0235-JTL (Del. Ch. Oct. 23, 2019) and should be consulted by anyone who needs to understand the components of this important doctrine.

https://www.delawarelitigation.com/2019/10/articles/chancery-court-updates/chancery-explains-step-transaction-doctrine-and-defines-affiliate/

Delaware Forum Selection Clause Controls Over Foreign Exclusive Jurisdiction Statute

The recent Delaware Court of Chancery decision in AlixPartners, LP v. Mori, No. 2019-0392-KSJM (Del. Ch. Nov. 26, 2019) rejected an effort to dismiss a Delaware action notwithstanding the provision in an agreement that provided for a forum in a foreign country, and the apparent law of that foreign country that also supported exclusive jurisdiction in that country.

https://www.delawarelitigation.com/2019/12/articles/chancery-court-updates/delaware-forum-selection-clause-controls-over-foreign-exclusive-jurisdiction-statute/

In a rare example of the Court of Chancery denying a a former corporate officer’s advancement claim–after an initial decision granting it–the court changed its prior opinion, after a complaint in the underlying case was amended to limit the underlying claims at issue to post-employment breach of contract claims, and based on that amendment the court determined that the challenged actions, as amended, were not taken by the claimant as a former officer or former director, and therefore the duty for advancement was not triggered. See Carr v. Global Payments, Inc., C.A. No. 2018-0565-SG (Del. Ch. Dec. 11, 2019), in which the Court also noted that confidential information was not alleged to have been misused after the role as former officer ended.

The focus of the amended complaint was an alleged violation of a non-compete agreement, which this and other cases have viewed as primarily an employer/employee dispute–not an advancement matter. Also noteworthy was the court’s analysis of the provisions of the LLC agreement granting advancement–which relied on different wording than that contained in DGCL Section 145. The court expressed initial skepticism, as have other cases, when an attempt is made to amend an underlying complaint solely for purposes of evading an otherwise valid advancement obligation. This case proved different.

This case should be compared with the recent decision highlighted on these pages styled Ephrat v. medCPU, Inc., which provided a comprehensive analysis of Delaware case law involving advancement claims related to confidential data taken by a former officer and director–but primarily misused after the role of director and officer ended. See also Charney case highlighted on these pages, with a similar denial for post-employment activity.

Notably, the Carr case involved an acknowledgement that, despite this ruling, advancement was still required for underlying claims for breach of fiduciary duty.

A  more comprehensive review of this case, prepared by veteran corporate law writer Frank Reynolds, appears on these pages.

 

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.

A recent Court of Chancery opinion reversed an earlier advancement decision in favor of Heartland Payment System LLC ex-CEO Robert Carr after finding buyer Global Payments Inc.’s amended complaint narrowed its underlying suit against him to post-employment breach of non-compete contract claims, in Carr v. Global Payments Inc., et al., C.A. No. 2018-0565-SG, memorandum opinion (Del. Ch. Dec. 11, 2019).

Vice Chancellor Sam Glasscock III’s December 11 memorandum opinion granted Global’s motion to modify his October 31, ruling, which, he acknowledged, wrongly ordered the electronic payment processer to pay Carr’s legal bills based on his “substantial error of fact,” about the amended charges.

No longer pertains

After withdrawing that ruling on November 5 and agreeing to hear re-argument, he said in the December opinion that the amended complaint no longer “pertains” to Carr’s corporate officer status regarding the breach-of-contract charges and is now strictly an employer/employee matter.

He said the new complaint is not the result of “artful re-pleading” of the same alleged wrongs and now clearly sets out a new basis for breach-of-contract charges that steer clear of misuse of confidential information and actions taken before stepping down as CEO.

The advancement ruling is noteworthy because instead of focusing on the application of Section 145 of the Delaware General Corporation Law, it interpreted an advancement agreement patterned on Section 145 that was part of a limited liability company’s merger pact.

After Global bought Heartland in 2015 it had its new subsidiary file suit in federal court in New Jersey claiming Carr breached his fiduciary duty by giving his girlfriend inside information about the merger and used business secrets to form a competing company shortly after leaving.

Initially entitled

When Carr sued in the Delaware Chancery Court in July 2018 to force Heartland to pay for his defense of those charges, the vice chancellor initially found he was entitled to advancement under the merger pact, but the underlying New Jersey action was stayed during a criminal investigation in Connecticut.

When the stay was lifted in May 2019, Heartland and Global filed an amended complaint in New Jersey that dropped the initial misuse of confidential information charge and focused on breach of the non-compete and non-solicitation aspects of Carr’s conduct after he left Heartland.

One month later, they moved to modify the vice chancellor’s advancement order with regard to the breach-of-contract charge, arguing that that claim arose solely from Carr’s actions when he was no longer a Heartland officer and director and thus ineligible for advancement.

Vice Chancellor Glasscock initially found in favor of Carr but after agreeing to hear re-argument, he said a re-examination of the amended charges caused him to find that they “moot the advancement dispute by removing any claims that would trigger an advancement right.”

Not mere relabeling

He said he came to that conclusion despite being “wary of artful attempts at…mere relabeling of claims” and keeping in mind that “any ambiguities in advancement cases are required to be resolved in favor of enforcing the advancement right.”

He noted that the merger agreement’s drafters promised advancement rights for litigation that “arises out of or pertains to” Carr’s corporate officer status; he decided that “arises out of” and “pertains” were equally broad in scope, but “pertains” had the force of “part of” or “related to”.

Therefore, the suit’s remaining breach of duty and fraud charges warrant advancement because they pertain to his CEO duties the parties agreed, but Global argued  that claims for breach of a non-compete agreement are by nature an employer/employee dispute and thus not indemnifiable.

The vice chancellor said Delaware case law says such litigation involving post-separation use of confidential information gained while still in a corporate position “pertains” to his officer status and qualifies for advancement–but he said without that misuse, it would not, citing Brown v. LiveOps, 903 A.2d 324 (Del. Ch. 2006).

The first amended complaint clearly does not qualify for advancement because it “effectively erases all mention of confidentiality from the breach of contract claim…and focuses solely on his post-employment competition and solicitation activity,” he said, granting the motion to modify the advancement order.

 

The recent Delaware Chancery Court opinion in Ephrat v. medCPU, Inc., C.A. No. 2018-0052-MTZ (Del. Ch. June 26, 2019), remains noteworthy for two reasons, notwithstanding the large number of advancement decisions interpreting DGCL Section 145 appearing on these pages over the last 14 years:

(1)        It provides an anthology of prior Delaware decisions granting advancement to former directors or officers to defend claims regarding the use of confidential information acquired in their prior corporate capacity; and,

(2)        The opinion adds nuance to the existing abundant case law interpreting the threshold phrase “by reason of the fact”, which is one of the statutory prerequisites that must be satisfied for advancement claims to prevail.

Key Takeaways:

  • Despite the conduct at issue taking place post-termination, the “by reason of the fact” requirement of § 145 was satisfied because the underlying case involved the use of “Confidential Information” acquired while the former D&O was acting in his corporate capacity. (Although some conduct did not qualify and, thus, only partial advancement was granted).
  • This opinion compiles and discusses all the reported Delaware decisions that address the above circumstances in the § 145 context, and distinguishes one case, Lieberman, that does not grant advancement. See footnotes 42, 52, 56 and 69. See also page 19 which explains why Lieberman should be distinguished and why it is contrary to the great weight of authority on this issue.
  • The court also contrasts disputes relating to covenants-not-to-compete, and explains why those employer v. employee disputes typically involve personal disputes not in one’s corporate capacity–citing cases so holding. See footnote 74.

Adding to the multitude of Delaware decisions featured on these pages involving the right of corporate directors and officers to advancement of their fees incurred to defend claims against them, pursuant to DGCL Section 145, or by agreement, we offer highlights of Sider v. Hertz Global Holdings, C.A. No. 2019-0237-KSJM, Order (Del. Ch. June 17, 2019), a recent Delaware Court of Chancery ruling. Our highlights appear in the form of an article published in the current edition of The Delaware Business Court Insider, co-authored by yours truly and my colleague Chauna Abner. This decision comes in the form of an Order, but regular readers know that Orders and transcript rulings from the bench may be cited in Delaware briefs as authority.

In Sider, the Court denied a motion for interlocutory appeal of a decision granting advancement, reasoning that one of the requirements for such an appeal was not met: “that there is no just reason for denying the appeal.” Other basic but important advancement principles, and nuances, are recited by the court, with copious citations in robust footnotes.

Over the last 14 years that I have published this blog, I have compiled an annual review with a list of key Delaware corporate and commercial decisions that have widespread utility to practitioners, especially those court decisions that are not widely covered by other legal publications or the mainstream press. On a few occasions, I have prepared a mid-year review. This is one of those years.

A few weeks ago, I prepared highlights of key decisions published over the last 6 months or so (and in some instances a little beyond that period), for presentation to a large law firm based on the west coast. I’m “repurposing” my materials for that presentation by providing those case highlights below. For each blurb below, there is a link to a fuller overview as well as a link to the complete court opinion.

HIGHLIGHTS OF RECENT KEY DELAWARE CORPORATE AND COMMERCIAL DECISIONS–as of May 30, 2019

DELAWARE SUPREME COURT DECISIONS

Delaware Supreme Court Clarifies Appraisal Law

The Delaware Supreme Court, in a per curiam decision, recently determined that “deal price less synergies” was the appropriate determination of fair value in the appraisal action before it.  In Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., C.A. No. 11448-VCL (Del. Apr. 16, 2019), the Court reversed the Court of Chancery’s holding that “unaffected market price” was the fair value on the date of the merger. This case is the third in a recent trilogy of precedent-setting Delaware appraisal cases, preceded by DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017) and Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd, 177 A.3d 1 (Del. 2017).  This case has been the subject of extensive commentary by scholars and practitioners in the short time since its publication.

Link: https://www.delawarelitigation.com/2019/04/articles/delaware-supreme-court-updates/delaware-supreme-court-clarifies-appraisal-law/

Company Required to Produce Emails Among Management to Stockholders

The Delaware Supreme Court recently issued an opinion that clarifies the duty of a company to produce emails among its management in a Section 220 case. In KT4 Partners LLC v. Palantir Technologies, Inc., Del. Supr., No. 281, 2018 (Jan. 29, 2019), Delaware’s High Court addressed a demand under Delaware General Corporation Law (DGCL) Section 220 by a stockholder for corporate books and records, including emails among management, to allow the stockholder to investigate possible wrongdoing, such as the reasons behind amendments to an Investors’ Rights Agreement that severely reduced the original rights granted under that agreement.

Notably, the court in its opinion quoted from a law review article that yours truly co-authored on the topic, which explained why demands under DGCL Section 220 should often include electronically-stored information (ESI) such as emails. See footnote 76.

This opinion is noteworthy because it clarifies Delaware law and authoritatively describes those circumstances when a demand for books and records under DGCL Section 220 will require the company to produce ESI, such as emails among management, to the extent necessary for the proper purpose established in a Section 220 case.

Brief Overview:

The stockholder demand in this case stated as its purpose the investigation of mismanagement, including depriving investors of their right of first refusal under an investors’ agreement that was amended without the consent of all investors, as well as interfering with the sale of stock by a large stockholder. The Court of Chancery, in a decision highlighted on these pages, determined that although some books and records had to be produced, emails need not be. The Supreme Court disagreed with that ruling and affirmed in part, reversed in part, and remanded.

Importantly, the facts of this case include an acknowledgment by the company that it often did not follow corporate formalities such as preparing board resolutions and keeping minutes of board meetings, but rather often communicated by email and took action by email–including on matters that were the subject of the investigative purpose of the Section 220 demand.

Highlights of Key Aspects of the Court’s Ruling:

For busy readers, I provide bullet points of key aspects of this crucial decision, but those who need to be familiar with the nuances of this aspect of Delaware corporate litigation should read the entire 49-page opinion linked above.

Procedural Background:

  • The court discussed what appeared to be an issue of first impression about the standard of review regarding a dispute over the interpretation of the stated purpose in a Section 220 demand. The court explained that the standard of review for the scope of relief is abuse of discretion, but de novo review applies to questions of law such as whether the stated purpose under Section 220 is proper. Although contract interpretation is also subject to de novo review as a question of law, fact-intensive and judgment-based determinations are reviewed for abuse of discretion, and factual determinations that underlie the trial court’s interpretation of an ambiguous written document deserve the deference given to factual findings.
  • The Delaware Supreme Court found that the demand in this case did include an explicit reference to a request for electronic documents.
  • The core issue identified by the High Court was whether the Court of Chancery abused its discretion in ruling that emails and other ESI were not necessary to satisfy the purpose of investigating the wrongdoing alleged in this Section 220 case.

Basic Principles:

  • The court reviewed the basic principles and policy undergirding the qualified common law and statutory right to inspect corporate books and records. See Slip op. at 22 to 24.
  • The court observed that the scope of documents to which a stockholder is entitled under Section 220 is limited to those that are necessary to accomplish the proper purpose as stated in the demand. See Slip op. at 24 to 25.

Emails/ESI Production:

  • In explaining why ESI should be included in appropriate Section 220 cases, the Delaware Supreme Court quoted from a law review article on this topic co-authored by your truly. See footnote 76 (quoting Francis G.X. Pileggi, et al., Inspecting Corporate “Books and Records” in a Digital World: The Role of Electronically Stored Information, 37 Del. J. Corp. L. 163, 165 (2012)).
  • The court reviewed Delaware cases that previously addressed whether ESI such as emails should be included in a Section 220 request. See footnotes 71 to 74. See also Amalgamated Bank v. Yahoo!, Inc., a Chancery opinion highlighted on these pages that also cited the same law review article on this topic co-authored by yours truly that was quoted by the Supreme Court in the instant case. See, e.g., footnote 72 (citing a Court of Chancery Order allowing for imaging of a Blackberry in a Section 220 case.)
  • The court also explained, based on the facts and circumstances of this case, why emails and ESI had to be produced and were needed to accomplish the stated purpose. See Slip op. at 31. For example, the court explained that the company involved did not comply with required corporate formalities such as minutes of board meetings and that it often conducted corporate business informally, including over email, regarding the issues subject to the Section 220 demand. See footnote 77 and accompanying text. The ESI at issue included, for example,  an allegedly incriminating message sent via LinkedIn.
  • The court also emphasized that there may be some Section 220 cases where ESI may not be required to be produced by the company, such as those situations where the corporation has traditional, non-electronic documents that are sufficient to satisfy the needs of the Section 220 petitioner.
  • In this case, the company admitted that there were no hardcopy documents that addressed all of the requests, and that there were emails and other ESI that were responsive to the requests.
  • The court also provided practice tips for future litigants: there should be a cooperative effort to focus on the substantive data that should be produced–or in other words, focus on the information that is needed and that is available whether it be in hardcopy or in ESI format.

The court also addressed an unrelated issue. It rejected the argument that the company made that as a condition of production it could require the stockholder to file any suits based on the data received in the Delaware Court of Chancery. Although there have been cases that have imposed similar jurisdictional conditions, the court explained why such a condition should be the exception and not the norm.

SUPPLEMENT: Law360 published an article about this case in which they quoted my comments about the importance of the High Court’s opinion.

Link: https://www.delawarelitigation.com/2019/01/articles/delaware-supreme-court-updates/company-required-to-produce-emails-among-management-to-stockholders/

Supreme Court Explains the Implied Covenant of Good Faith and Fair Dealing

A recent Delaware Supreme Court decision is must-reading for those who need to know the latest iteration of Delaware law on the implied covenant of good faith and fair dealing. In Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, Del. Supr. No. 536, 2018 (Jan. 17, 2019), Delaware’s High Court provided the latest articulation of Delaware law on the multi-faceted doctrine of the implied covenant of good faith and fairing dealing. In connection with affirming in part and reversing in part a 176-page trial court opinion, which was highlighted on these pages, the Supreme Court agreed with the analysis of the trial court’s correct reading of the plain meaning of the LLC agreement at issue, but disagreed with the application by the trial court of the implied covenant.

 Highlights of the most recent authoritative explanation of the implied covenant under Delaware law are noted in the following bullet points:

  • When a board is given contractual discretion to make a choice, that is not a “gap” to be filled. Although “the vesting of a board with discretion does not relieve the board of its obligation to use that discretion consistently with the implied covenant of good faith and fair dealing,” the argument was not made in this case that the board exercised this contractual discretion in bad faith. See footnotes 92 and 93 and accompanying text.
  • The court explained the two common situations where the implied covenant often applies. The first, at issue in this case, is when it is argued that a situation has arisen that was unforeseen by the parties and where the agreement’s express terms do not cover what should happen. See footnote 93.
  • The next situation is when a party to the contract is given discretion to act as to a certain subject and it is argued that the discretion has been used in a way that is impliedly proscribed by the contract’s express terms. Id.
  • “When a contract confers discretion on one party, the implied covenant requires that the discretion be used reasonably and in good faith.” Id.
  • Delaware’s High Court explained that the “implied duty of good faith and fair dealing is not an equitable remedy for rebalancing economic interests after events that could have been anticipated, but were not, later adversely affected one party to a contract.” See footnote 109 and accompanying text.
  • Rather, “the covenant is a limited and extraordinary legal remedy.” See footnote 110.
  • The Supreme Court added that the implied covenant “does not apply when the contract addresses the conduct at issue, but only when the contract is truly silent concerning the matter at hand. Even where the contract is silent, an interpreting court cannot use an implied covenant to re-write the agreement between the parties, and should be most chary about implying a contractual protection when the contract could easily have been drafted to expressly provide for it.” See footnotes 110 to 113 and accompanying text.

Link: https://www.delawarelitigation.com/2019/01/articles/delaware-supreme-court-updates/supreme-court-explains-the-implied-covenant-of-good-faith-and-fair-dealing/

Delaware Supreme Court Clarifies Ab Initio Requirement for BJR Review

The Delaware Supreme Court recently clarified the “ab initio” requirement announced in the Kahn v. M&F Worldwide Corp. case as part of the set of standards that would allow for the BJR standard to apply to a challenged merger. See Olenik v. Lodzinski, No. 392, 2018 (Del. Supr., rev. April 11, 2019).  The High Court determined that the requirement was not satisfied based on the facts of the instant case because the “economic bargaining took place prior to the date” when the protections announced in the Kahn v. M&F Worldwide Corp. case needed to be in place.

Much commentary has already been written about this case, so it will not be covered thoroughly on these pages, but I refer to prior decisions that have applied the ab initio requirement, for background purposes, as noted on these pages.

 Link: https://www.delawarelitigation.com/2019/04/articles/delaware-supreme-court-updates/delaware-supreme-court-clarifies-ab-initio-requirement-for-bjr-review/ 

Supreme Court Affirms Akorn Decision

The Delaware Supreme Court, in Akorn, Inc. v. Fresenius Kabi AG, et al., Del. Supr., No. 535, 2018 (Dec. 7, 2018), affirmed in a 3-page order, two days after oral argument, the Court of Chancery’s 253-page decision which was highlighted on these pages, and which is thought to be the first Delaware decision to find that a “material adverse effect” clause was triggered in such a way as to allow an acquiring party to terminate a merger pre-closing. Much has been written in trade publications about the Akorn case. See, e.g., here and here .

Link: https://www.delawarelitigation.com/2018/10/articles/chancery-court-updates/chancery-allows-termination-of-merger-agreement-based-on-material-adverse-change/

COURT OF CHANCERY DECISIONS

Chancery Instructs on DGCL Merger Requirements

A recent Delaware Court of Chancery opinion began by describing the complaint as reading like a law school exam designed to test the knowledge of a student regarding the requirements in the DGCL that must be satisfied in connection with a merger, and the court commented that the company would not have done well on the exam.

In Mehta v. Mobile Posse, Inc., C.A. No. 2018-0355-KSJM (Del. Ch. May 8, 2019), the court identified the six primary issues in this case as follows:

(1) Whether DGCL Section 262 was not complied with in connection with the failure to notify stockholders of their appraisal rights within the required timeframe;

(2) Whether DGCL Section 228 was not complied with due to the failure to send prompt notice of the written stockholder consents;

(3) Whether the merger agreement, or documents it incorporates, failed to comply with DGCL Section 251 by not including the amount of cash the preferred stockholders would receive for their shares;

(4) Whether the stockholder consents did not enjoy the ratifying effect under DGCL Section 144;

(5)  Whether the director defendants breached their fiduciary duty of disclosure; and

(6) Whether the director defendants breached the fiduciary duty of loyalty because the merger was a self-dealing transaction and not entirely fair.  With one small exception, the court found that the statutory violations were sufficiently established at the early procedural stage of a motion for judgment on the pleadings.

Key Highlights of Decision:

  • As an initial procedural matter, in connection with this motion for judgment on the pleadings, the court observed that it was not well-established in Delaware case law or Rules of Civil Procedure whether a “supplemental notice” attached to a motion for judgment on the pleadings could be considered “part of the record or pleadings.”  Based on this opinion, however, it is now established that under Delaware law, under some circumstances, it is now possible for such a supplemental notice to be included as part of the pleadings in such a procedural posture.  See, e.g., footnotes 1 through 6 and accompanying text.

DGCL Section 262:

  • The company sought a “do-over” or a “mulligan” for its statutory errors, because it purported to send proper notices required by DGCL Section 262–only after suit was filed.  Three problems with that approach are that: (i) Such a “replicated remedy proposal” had never before been blessed by a Delaware court; (ii) Even the supplemental notice proposed was itself wrong (in part because it quoted the statute of another statute); and (iii) trying to make a “supplemental notice” sent after the lawsuit was filed does not always make it part of the pleadings, although as noted above–in some circumstances–based on the opinion in this case, it is now possible to do so.  See Slip op. at 13.

DGCL Section 228:

  • Based on an amendment to the statute passed in 2017, Section 228 no longer requires that the written consent of stockholders be dated next to each signature.  See Slip op. at 19.
  • The court addressed the “less than bright-line rule” about whether or to what extent disclosures are required in connection with written consents of stockholders pursuant to Section 228, but cases cited by the court in this opinion support the view that in this case the company is not entitled to judgment on the pleadings on this issue in light of the lack of material data, or their supplying of incorrect data, with the solicitations for consents that were sent to the minority stockholders in this case.

DGCL Section 228(e)–Prompt Notice Requirement:

  • The prompt notice requirement under Section 228(e) requires that notice of action by written consent of stockholders to those who did not consent must be prompt.  Nonetheless, the exact timetable for such “prompt notice” is not defined in the statute.  One case found that five months was not prompt.  In this matter, notice was given after the Section 262 appraisal deadline, which the court found as a sufficient basis to deny the motion for judgment on the pleadings filed by the company (rather audaciously) in this case.

DGCL Section 251(b):

  • This section of the DGCL requires that a merger agreement include specified details about the deal terms, including compensation to stockholders, but the company failed to comply with this requirement.

DGCL Section 144:

  • The court held that the safe harbor under Section 144(a)(2) was not satisfied in this matter because the stockholders were not given material facts about the interests of the directors in the merger.

The court also denied the company’s motion for judgment on the pleadings regarding claims for breach of fiduciary duty.

Link: https://www.delawarelitigation.com/2019/05/articles/chancery-court-updates/chancery-instructs-on-dgcl-merger-requirements/

Chancery Applies Corporate Advancement Case Law to LLC Context

A recent Delaware Court of Chancery decision interpreted the advancement provisions of an LLC Agreement by applying case law interpreting DGCL Section 145 in the corporate context.  In Freeman Family LLC v. Park Avenue Landing LLC, C.A. No. 2018-0683-TMR (Del. Ch. Apr. 30, 2019), the court reviewed the applicability of “defined phrases” that are familiar prerequisites for advancement in the corporate context pursuant to DGCL Section 145, and analyzed that same language that was used in an LLC agreement provision granting advancement.

The highlights of this decision are based on the assumption that the reader is familiar with the principles of advancement for officers and directors pursuant to DGCL Section 145, and the leading Delaware court decisions on the topic–even if they are not aware that I have written several book chapters on advancement and published multiple articles on advancement and handled many advancement cases.   

 Brief Background:

This case involved a request for advancement by a member (not a manager) of an LLC seeking advancement for the cost of defending a suit in New Jersey brought by the managing member of the LLC relating to the call right of the member under the LLC Agreement.  (The plaintiff-member of the LLC involved in this case was itself an LLC.)

 Issues Addressed:

The two issues that the court addressed in this case are:  (1) Does corporate case law apply to the provisions for advancement in an LLC Agreement which contains language that mirrors the corporate statute, DCGL Section 145; and (2)  Whether the underlying action for which advancement is sought, arises “by reason of the fact” that the party seeking advancement acted in its “official” capacity?  The court answered both questions in the affirmative.

 Highlights of this Decision–Assuming Familiarity with Delaware Corporate Advancement Case Law:

  • The court referenced the well-known truism that advancement cases are particularly appropriate for resolution on a paper record, such as via dispositive motions.  See footnote 22 and accompanying text.
  • The court cited other Delaware cases that have applied corporate case law to analyze the contractual terms of advancement in an LLC Agreement.  See, e.g., Hyatt v. Al Jazeera American Holdings, II, LLC, 2016 WL 1301743 (Del. Ch. Mar. 31, 2016) (highlighted on these pages previously)See also other cases cited at footnotes 36, 37 and 38.
  • The court explained that LLCs and corporations differ most pertinently in regard to indemnification: “mandating it in the case of corporate directors and officers who successfully defend themselves, but leaving the indemnification of managers or officers of LLCs to private contract.”  See footnote 46 and accompanying text.
  • The court recited the guidelines that the Delaware courts used to determine if someone was acting “by reason of the fact”–for purposes of being entitled to either indemnification or advancement, and restated the familiar standard that the operative phrase will be satisfied “if there is a nexus or a causal connection between any of the underlying proceedings and one’s official corporate capacity . . . without regard to one’s motivation for engaging in that conduct.”  See footnotes 50 and 51 and accompanying text.
  • By contrast, the court cited examples of cases where the “by reason of the fact” requirement was not satisfied, which is best exemplified by disputes involving personal contractual obligations that do not involve the exercise of judgment, discretion, or decision-making authority on behalf of the corporation.  See footnote 53 and accompanying text.  Because the party seeking advancement in this case was a member and not an officer or a director, the context was unusual, but the LLC Agreement clearly defined the responsibilities of the member.
  • The court reasoned that the causal relationship between the official capacity of the member and the underlying lawsuit was met for several reasons: (i) The underlying case in New Jersey was about the failure of the member to carry out its responsibilities specified in the LLC Agreement: (ii) The underlying lawsuit in New Jersey is based on whether the member discharged its official duties such that the call rights could be exercised; and (iii) The underlying dispute fully implicates whether or not the member seeking advancement carried out its official duties.  Thus, the court held that the “by reason of the fact” requirement and the “official capacity requirement” were met.
  • The court distinguished five cases in which advancement or indemnification claims were denied because the underlying litigation involved a personal interest that lacked a sufficient connection to official duties.  Those five cases that were distinguished are cited in footnote 56–most of which have been highlighted on these pages:  Bernstein v. TractManager, Inc., 953 A.2d 1003 (Del. Ch. 2007); Cochran v. Stifel Fin. Corp., 2000 WL 1847676 (Del. Ch. Dec. 13, 2000) (rev’d in part on other grounds, 809 A.2d 555 (Del. 2002)); Lieberman v. Electrolytic Ozone, Inc., 2015 WL 5035460 (Del. Ch. Aug. 31, 2015); Dore v. Sweports, Ltd., 2017 WL 45469 (Del. Ch. Jan. 31, 2015); Charney v. Am. Apparel Inc., 2015 WL 5313769 (Del. Ch. Sept. 11, 2015).
  • Regarding whether the “undertaking” provided by the party seeking advancement satisfied the statutory undertaking requirement, the court ruled that the sufficiency of an undertaking is determined by looking at the substance–and not the form alone–of the document containing the undertaking.

 Postscript: It was recently reported by The Chancery Daily that the Vice Chancellor who wrote this opinion published it the day after giving birth to a baby boy. Wow. That’s a dedicated jurist. Congratulations to Her Honor and her family on their new addition.

Link: https://www.delawarelitigation.com/2019/05/articles/chancery-court-updates/chancery-applies-corporate-advancement-case-law-to-llc-context/

Chancery Finds Usurpation of Corporate Opportunity

Delaware case law is well-established regarding the aspect of the fiduciary duty of loyalty that prohibits a corporate director from usurping a corporate opportunity. A recent decision from the Delaware Court of Chancery applies that well-settled prohibition in a flexible manner to a set of facts that have apparently not been squarely addressed in prior precedent.  In Personal Touch Holding Corp. v. Glaubach, C.A. No. 11199-CB (Del. Ch. Feb. 25, 2019), the court awarded damages for the breach of this subset of fiduciary duty, as well as for other breaches of fiduciary duty.

Basic Background Facts:

This case involved a co-founder who also served as a president and director of a New York-based provider of healthcare services. He was removed when the company discovered various transgressions. The former director purchased an office building in his individual capacity–secretly–even though the court found that the former director had been aware that the company was interested for several years in purchasing a similar building for its own use.  The former director then offered to lease the building back to the company at what the court found to be above-market rental rates.

Key Principles of Law:

This short blog post assumes that readers are familiar with the basic principles involved with the usurpation of corporate opportunities, and will merely highlight some of the key statements of law and the court’s reasoning in this 84-page opinion.

The well-known elements of a claim based on the corporate opportunity doctrine have been stated frequently in prior Delaware cases. Those familiar with corporate litigation will recognize the following four elements of a claim for usurpation of corporate opportunity:

“ (1)      The corporation is financially able to exploit the opportunity;

(2)      The opportunity is within the corporation’s line of business;

(3)      The corporation has an interest or expectancy in the opportunity;

(4)      By taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation.”

Slip op. at 36-38.

The court explained that Delaware Supreme Court decisions have referred to some of these elements in the disjunctive even though they are often quoted as being conjunctive. Specifically, proof of either the third element or the fourth element would sustain a corporate opportunity claim.

Moreover, the court decides the viability of a corporate opportunity claim by weighing the four factors in a holistic fashion and no one factor is dispositive. Id.

Key Reasoning of the Court:

  • The court rejected the argument that the purchase of the office building was not in the line of business of the healthcare company involved, which historically leased office space, because the “line of business factor” was in either inapplicable or was satisfied because the company had a clear “interest and expectancy” in the opportunity. In addition to that factor having a flexible meaning, the court explained that latitude should be allowed for development and expansion of a business, and the Delaware courts have broadly interpreted the nature of the corporation’s business when determining whether a corporation had an interest in a opportunity.
  • Regardless, the court found that the line of business test was not relevant where, as here, the company had a clear interest and expectancy in acquiring the building, and the opportunity presented related to an operational decision about how to expand the business as opposed to an opportunity to acquire a new business.
  • The court further reasoned that even if the opportunity was not within the existing line of business, it was sufficient that the company had a “clear interest and expectancy” at the time the opportunity arose. Id. at 44-47.
  • Regarding the fourth factor, the court instructed that a corporate officer or director was prohibited from taking an opportunity for his own “if the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation.”
  • The court elaborated by observing that the corporate opportunity doctrine is implicated where the fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the corporation and the self-interest of the director as actualized by the exploitation of the opportunity.” Id. at 47-49.
  • The court also rejected an argument that the employment agreement of the former director allowed him to pursue other business interests outside of the company, and to devote a material portion of his time to other business interests. The court found that contractual defense to be unavailing in part because that provision did not allow the defendant to compete with the company for opportunities in which the company had an interest or expectancy. In addition, the employment agreement also prohibited the former director and president from engaging in activities which were “competitive with” the business of the company.
  • The court applied the entire fairness test because the former director was on both sides of the transaction involving a lease of the building to the company, and also because the director received a personal benefit from the transaction that was not received by the shareholders generally. Id. at 53.
  • The court also explained that charging the company an above-market rate for rent was unfair self-dealing and a breach of the duty of loyalty–regardless of whether the former director acted in subjective good faith.

As a side note, the court also found a separate breach of fiduciary duty as a result of the former director engaging in a “letter-writing campaign” over a several month period in which the former director sent harassing and disturbing anonymous letters to board members, employees and the lender of the company which caused harm to the company by hurting morale and causing distraction–in addition to attempting to sabotage the company’s relationship with its primary lender. Slip op. at 76-83.

Link: https://www.delawarelitigation.com/2019/03/articles/chancery-court-updates/chancery-finds-usurpation-of-corporate-opportunity/

Chancery Clarifies Director’s Right to Corporate Records

A recent Delaware Court of Chancery decision addressed the important issue of the right of directors to be given access to corporate records. In Schnatter v. Papa John’s International, Inc., C.A. No. 2018-0542-AGB (Del. Ch. Jan. 15, 2019), Delaware’s court of equity considered a claim under Section 220(d) of the Delaware General Corporation Law (DGCL) by the founder and largest stockholder of the Papa John’s pizza chain who was forced out as the CEO but retained his position as a director.  He sought to obtain books and records in his capacity as a director to support an investigation that the other directors breached their fiduciary duties by improperly ousting him for unjustified reasons.

Key Bullet Points that Make this Case Noteworthy include the following:

  • The court required the Defendant-Directors to produce their text messages and their private emails, that they sent and received, that related to the specific issues in contention. Prior Chancery decisions have required the production of such personal communications that related to corporate business but such a ruling is still notable. For example, a few years ago, in Amalgamated Bank v. Yahoo!, Inc., highlighted on these pages, the Court of Chancery ordered a similar scope of production–and also cited to a law review article that yours truly published in which my co-authors and I explained why electronically stored information (ESI), including text messages and private emails, should often be included within the scope of a DGCL Section 220 demand. See law review article co-authored by yours truly which argued that the court should often include ESI as part of the obligation to produce records under Section 220. See 37 Del. J. Corp. L. 163, 165 (2012), highlighted on these pages here.
  • It is well-established that directors have nearly unfettered rights to access to books and records of a corporation in which they serve. Unlike a stockholder, when a director makes a demand for books and records under Section 220(d), the corporation has the burden to establish that the director’s demand for books and records is based an improper purpose.
  • Unlike the impact of a stockholder filing a plenary action before a Section 220 case is complete, when a director files a plenary action before a final ruling in a Section 220 case, that will not necessarily bar the continuation of Section 220 claims and it will not otherwise moot the Section 220 claims. See generally CHC Investments, Inc. v. FirstSun Bancorp, C.A. No. 2018-0610-KSJM (Del. Ch. Jan. 24, 2019)(Section 220 stockholder demand case dismissed due to parallel plenary action.)
  • The court observed that a director should not be required to sign a confidentiality agreement as a condition to obtaining records because a director already has a fiduciary duty to keep them confidential—as compared to stockholders who routinely are required to sign a confidentiality agreement as a condition to obtaining records pursuant to a Section 220 demand. See generally Murfey v. WHC Ventures, LLC, C.A. No. 2018-0652-MTZ (Del. Ch., Jan.23, 2019)(proposed confidentiality order rejected by Court as non-compliant with Chancery Rule 5.1 because it did not allow for filing confidential documents with the court–confidentially.)

Link: https://www.delawarelitigation.com/2019/01/articles/chancery-court-updates/chancery-clarifies-directors-right-to-corporate-records/

Advancement for Counterclaims Granted Despite Withdraw of Covered Claim

A recent transcript ruling by the Delaware Court of Chancery in Gasgarth v. TVP Investments, LLC, C.A. No. 2018-0621-JTL, transcript ruling (Del. Ch. Dec. 7, 2018), explained that the right to advancement was not extinguished by an amendment of a counterclaim to specifically withdraw breaches of fiduciary duty counterclaims and remove factual allegations relating to the service of the plaintiffs (counterclaim defendants) as directors and officers.

The court reasoned that it is not bound by the four-corners of a pleading, but rather will view the context of the litigation as a whole to determine if advancement is warranted in light of all the facts and circumstances of the case and the role that the directors and officers played in connection with the claims against them.

Relying on Delaware precedent, the court in this transcript ruling also included as part of the “fees on fees” awarded, a success bonus, which was part of the engagement letter with counsel.

Link: https://www.delawarelitigation.com/2019/01/articles/chancery-court-updates/advancement-for-counterclaims-granted-despite-withdraw-of-covered-claim/

Chancery Addresses “Commercially Reasonable Efforts” Standard

When the phrase “commercially reasonable efforts” appears as a standard of performance in contracts, it seems predetermined to generate litigation, and the recent Court of Chancery decision in Himawan v. Cephalon, Inc., C.A. No. 2018-0075-SG (Del. Ch. Dec. 28, 2018), supports that observation. Although the agreement in this case had a contractual definition for “commercially reasonable efforts”, prior Delaware decisions highlighted on these pages that discuss this phrase should be of relevance to anyone who needs to know what the Delaware cases say about this somewhat amorphous standard, and similarly-phrased “efforts clauses”.

Why this decision is noteworthy: The most notable aspect of this decision is its collection of Delaware cases interpreting various iterations of “efforts clauses”. See footnotes 83 to 85.

Brief overview: This case involved an earn-out dispute and a claim by the seller that it did not receive milestone payments pursuant to an earn-out provision because the buyer did not use commercially reasonable efforts to reach the milestones. The buyer was the pharmaceutical company Cephalon, but Teva Pharmaceuticals later bought Cephalon. The product at issue was an antibody that would allow an organism’s immune system to overcome disease-causing pathogens. As with new drugs, the process to bring antibodies to market is long, difficult and risky.

The earn-out in the merger agreement in this case was payable upon the meeting of certain milestones in the process of obtaining  approval by government agencies for the antibody to treat two different conditions. The buyer agreed to use “commercially reasonable efforts” to develop the antibody and achieve those milestones. The seller claims that the buyer did not comply with that efforts clause.

Key takeaways:

  • The Court provides an excellent collection of Delaware decisions that have wrestled with various permutations of “efforts clauses”. See footnotes 83 to 85 and accompanying text. The Court categorizes the collected decisions into the following groups, some of which are overlapping: (i) motions to dismiss (at the pleadings stage); (ii) post-trial decisions; (iii) post-merger decisions (often involving a related earn-out clause); and (iv) pre-merger decisions where the efforts clause applied to the satisfaction of a condition to closing.
  • The agreement involved in this case provided a contractual definition for “commercially reasonable efforts” as follows: “the exercise of such efforts and commitment of such resources by a company with substantially the same resources and expertise as [Cepahlon], with due regard to the nature of efforts and cost required for the undertaking at stake.”
  • The Court observed that the parties agreed that the foregoing is an “objective standard”, but the Court described the contractual definition as “inartfully” drafted and ambiguous. Also, in the context of denying a Motion to Dismiss this claim, the Court found that neither side offered a reasonable interpretation of this contract provision (as compared to another basis to deny an MTD: when both sides offer reasonable, but differing, interpretations.)
  • Based on Delaware’s version of Rule 12(b)(6)–which is not as stringent as the current Federal standard–the Court found that there was a “reasonably conceivable set of circumstances susceptible of proof” in which (allowing for factual issues at this early stage of the case), it could be shown that companies with similar resources and expertise as Cephalon are currently developing treatments for a similar antibody as the one at issue in this case.

Link: https://www.delawarelitigation.com/2018/12/articles/chancery-court-updates/chancery-addresses-commercially-reasonable-efforts-standard/

Chancery Rules on Limits of Forum-Selection Clauses in Corporate Documents

A recent seminal decision of the Delaware Court of Chancery must be included in the lexicon of every lawyer who wants to understand the boundaries of Delaware law on forum-selection clauses in corporate documents. In the case of Sciabacucchi v. Salzberg, C.A. No. 2017-0931-JTL (Del. Ch. Dec. 19, 2018), the Court determined that a forum-selection clause in a certificate of incorporation was invalid and ineffective to the extent that it purported to “require any claim under the Securities Act of 1933 to be brought in federal court” (the “Federal Forum Provisions”).

Why this Case is Noteworthy: The court reasoned in its holding that: “The constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.  In this case, the Federal Forum Provisions attempt to accomplish that feat.  They are therefore ineffective and invalid.

Overview of Key Points:

This opinion is destined to form part of the bedrock of foundational Delaware corporate decisions and could rightly be the subject of a lengthy law review article, but for purposes of this quick blog post, I will merely highlight a few of the more notable excerpts in bullet points.

  • A substantial basis for the court’s reasoning was a prior decision from the Court of Chancery which upheld the validity of corporate bylaws that required claims based on the internal affairs doctrine and related claims to be brought exclusively in the Court of Chancery. That decision by the current Chief Justice of Delaware, writing at the time as the Chancellor, was Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. June 25, 2018).
  • Although the Boilermakers case involved bylaws, the Sciabacucchi decision explained why that same reasoning applied to a certificate of incorporation which is governed by similar provisions in the Delaware General Corporation Law (DGCL). The court in Sciabacucchi explained that the reasoning in Boilermakers focused on the ability to enforce forum-selection clauses that related to the internal corporate matters of a Delaware corporation as opposed to external matters, such as claims arising under the Securities Act of 1933.
  • The Court buttressed its reasoning by referring to the codification of the Boilermakers decision, shortly after its publication, by means of the adoption of a new Section 115 of the DGCL. In connection with that new DGCL section, the Delaware General Assembly also passed new amendments to Sections 102 and 109 of the DGCL which prohibit fee-shifting provisions in the certificate of incorporation or bylaws particularly in connection with claims related to the internal affairs of a corporation as defined by DGCL Section 115.
  •  The Court’s reasoning was also supported by reference to what the court referred to as “first principles.” Those first principles included several basic tenets of corporate law such as the following: (i) Although the document filed with the state that gives rise to an artificial entity such as a corporation, and confers powers on it, is a contract, it is not an ordinary private contract among private actors; (ii) The certificate of incorporation is a multi-party contract that includes the State of Delaware. Unlike an ordinary contract, it also includes terms by reference that are imposed by the DGCL; (iii) Unlike an ordinary contract, a charter can only be amended to the extent that it complies with the DGCL; (iv) The DGCL specifies what provisions a charter may or may not include; and (v) Although the courts enforce both types of contracts, when enforcing relationships created by the corporate contract, the courts use an overlay of fiduciary duty. See pages 38 to 42 and footnotes 111 to 125.
  • A thorough analysis of the contours and policy behind the internal affairs doctrine is an important feature of this opinion. See, e.g., pages 41-46.

In sum, the court reasoned that the “constitutive documents of a Delaware corporation cannot bind the plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.” The opinion provides extensive citations to substantial scholarship, case law and statutes.

Prof. Ann Lipton provides extensive insights in her blog post about this case with links to her articles on the topic. The good professor’s scholarship on this issue was also cited by the court in the above opinion.

Many cases have been highlighted on this blog regarding forum-selection clauses in private agreements. See, e.g., here and here. In some of the posts on these pages about cases involving forum-selection clauses, a graphic of the Roman Forum adds color as well as an etymological connection.

SUPPLEMENT: Professor Stephen Bainbridge, a prolific corporate law scholar, kindly links to this post on his blog.

Link: https://www.delawarelitigation.com/2018/12/articles/chancery-court-updates/chancery-rules-on-limits-of-forum-selection-clauses-in-corporate-documents/

A recent Delaware Court of Chancery decision interpreted the advancement provisions of an LLC Agreement by applying case law interpreting DGCL Section 145 in the corporate context.  In Freeman Family LLC v. Park Avenue Landing LLC, C.A. No. 2018-0683-TMR (Del. Ch. Apr. 30, 2019), the court reviewed the applicability of “defined phrases” that are familiar prerequisites for advancement in the corporate context pursuant to DGCL Section 145, and analyzed that same language that was used in an LLC agreement provision granting advancement.

The highlights of this decision are based on the assumption that the reader is familiar with the principles of advancement for officers and directors pursuant to DGCL Section 145, and the leading Delaware court decisions on the topic–even if they are not aware that I have written several book chapters on advancement and published multiple articles on advancement and handled many advancement cases.   

Brief Background:

This case involved a request for advancement by a member (not a manager) of an LLC seeking advancement for the cost of defending a suit in New Jersey brought by the managing member of the LLC relating to the call right of the member under the LLC Agreement.  (The plaintiff-member of the LLC involved in this case was itself an LLC.)

Issues Addressed:

The two issues that the court addressed in this case are:  (1) Does corporate case law apply to the provisions for advancement in an LLC Agreement which contains language that mirrors the corporate statute, DCGL Section 145; and (2)  Whether the underlying action for which advancement is sought, arises “by reason of the fact” that the party seeking advancement acted in its “official” capacity?  The court answered both questions in the affirmative.

Highlights of this Decision–Assuming Familiarity with Delaware Corporate Advancement Case Law:

·     The court referenced the well-known truism that advancement cases are particularly appropriate for resolution on a paper record, such as via dispositive motions.  See footnote 22 and accompanying text.

·     The court cited other Delaware cases that have applied corporate case law to analyze the contractual terms of advancement in an LLC Agreement.  See, e.g., Hyatt v. Al Jazeera American Holdings, II, LLC, 2016 WL 1301743 (Del. Ch. Mar. 31, 2016) (highlighted on these pages previously)See also other cases cited at footnotes 36, 37 and 38.

·     The court explained that LLCs and corporations differ most pertinently in regard to indemnification: “mandating it in the case of corporate directors and officers who successfully defend themselves, but leaving the indemnification of managers or officers of LLCs to private contract.”  See footnote 46 and accompanying text.

·     The court recited the guidelines that the Delaware courts used to determine if someone was acting “by reason of the fact”–for purposes of being entitled to either indemnification or advancement, and restated the familiar standard that the operative phrase will be satisfied “if there is a nexus or a causal connection between any of the underlying proceedings and one’s official corporate capacity . . . without regard to one’s motivation for engaging in that conduct.”  See footnotes 50 and 51 and accompanying text.

·     By contrast, the court cited examples of cases where the “by reason of the fact” requirement was not satisfied, which is best exemplified by disputes involving personal contractual obligations that do not involve the exercise of judgment, discretion, or decision-making authority on behalf of the corporation.  See footnote 53 and accompanying text.  Because the party seeking advancement in this case was a member and not an officer or a director, the context was unusual, but the LLC Agreement clearly defined the responsibilities of the member.

·     The court reasoned that the causal relationship between the official capacity of the member and the underlying lawsuit was met for several reasons: (i) The underlying case in New Jersey was about the failure of the member to carry out its responsibilities specified in the LLC Agreement: (ii) The underlying lawsuit in New Jersey is based on whether the member discharged its official duties such that the call rights could be exercised; and (iii) The underlying dispute fully implicates whether or not the member seeking advancement carried out its official duties.  Thus, the court held that the “by reason of the fact” requirement and the “official capacity requirement” were met.

·     The court distinguished five cases in which advancement or indemnification claims were denied because the underlying litigation involved a personal interest that lacked a sufficient connection to official duties.  Those five cases that were distinguished are cited in footnote 56–most of which have been highlighted on these pages:  Bernstein v. TractManager, Inc., 953 A.2d 1003 (Del. Ch. 2007); Cochran v. Stifel Fin. Corp., 2000 WL 1847676 (Del. Ch. Dec. 13, 2000) (rev’d in part on other grounds, 809 A.2d 555 (Del. 2002)); Lieberman v. Electrolytic Ozone, Inc., 2015 WL 5035460 (Del. Ch. Aug. 31, 2015); Dore v. Sweports, Ltd., 2017 WL 45469 (Del. Ch. Jan. 31, 2015); Charney v. Am. Apparel Inc., 2015 WL 5313769 (Del. Ch. Sept. 11, 2015).

·     Regarding whether the “undertaking” provided by the party seeking advancement satisfied the statutory undertaking requirement, the court ruled that the sufficiency of an undertaking is determined by looking at the substance–and not the form alone–of the document containing the undertaking. 

Postscript: It was recently reported by The Chancery Daily that the Vice Chancellor who wrote this opinion published it the day after giving birth to a baby boy. Wow. That’s a dedicated jurist. Congratulations to Her Honor and her family on their new addition.