Gerber v. Enterprise Products Holdings, LLC, Del. Supr., No. 46, 2012 (June 10, 2013).

Issue Presented:  This seminal Delaware Supreme Court decision addresses the important, nuanced issue of whether a contract provision that presumes good faith can preclude a claim for a breach of the implied covenant of good faith and fair dealing.

Short Answer:  No. The concept of good faith described in the agreement in this case is different from the concept found in the statutorily implied covenant of good faith and fair dealing.  The contractual waiver in an LP agreement of the fiduciary duty of good faith, and the substitute of a new contractual definition for good faith, is not consistent with the same concept of good faith contained in the implied covenant.

Practice Note: This Delaware Supreme Court opinion needs to be distinguished from a recent Delaware Supreme Court decision in Brinckerhoff v. Enbridge Energy Company, Inc., a decision of last month highlighted on these pages here, which also dealt with a presumption of good faith in a limited partnership agreement, but importantly, the Delaware high court in that decision did not address the effectiveness of that conclusive presumption because the ruling relied on a separate holding that the complaint failed to allege facts suggesting bad faith.

Therefore, it remains noteworthy that this is the first Delaware Supreme Court decision that directly addresses the important, nuanced aspect of the presumption of good faith in limited partnership agreements to the extent it compares that contractual presumption, specifically, with the implied covenant of good faith and fair dealing.  Recent Chancery decisions involving similar issues might need to be revisited in light of this opinion.

Background

The first ten-pages or so of the opinion refer to the labrynthine transactions involving multiple related entities.  In order for the focus of this short overview to remain on the legal principles announced, I will not belabor the confusing overlapping entities which Delaware’s high court used three separate charts to outline in order to avoid confusion.

In addition, there is a related case that the court refers to as Gerber I, reported at Gerber v. EPE Holdings, LLC, 2011 WL 4538087 (Del. Ch. Sept. 29, 2011).  The Chancery decision that was appealed from in this case is styled as Gerber v. Enterprise Products Holdings, LLC, 2012 WL 34442 (Del. Ch. Jan. 6, 2012) (“Gerber II”).

Claims Made

The complaint in this case alleged breaches of express contractual duties, as well as the implied covenant of good faith and fair dealing, and tortious interference.  In a January 2012 decision, the Court of Chancery granted a motion to dismiss.

Applicable Statute and Contract Terms

The Court of Chancery relied on Section 17-1101(d) of the Delaware Revised Uniform Limited Partnership Act (DRULPA), that allows for a general partner’s duties, including fiduciary duties, to be expanded or restricted or eliminated except that the agreement may not eliminate the implied contractual covenant of good faith and fair dealing.  The Vice Chancellor determined that Section 1101(d) was used in the partnership agreement to supplant the fiduciary duties to which the general partner and other fiduciaries would have been subject.  The agreement expressly provided for the conduct to be in good faith, which was defined as a “belief that the determination or other action is in the best interest of the partnership.”

The partnership agreement also created two separate layers of protection to insulate from judicial review whether the contractual duty was satisfied.  The first layer covered conflict of interest transactions and provided safe harbors.

The second layer of insulation from judicial review was afforded by Section 7.10(b), which was not limited to conflict of interest transactions and created “a conclusive presumption” that the general partner did act in good faith when enumerated conditions were satisfied.  Those conditions included relying on opinions of experts, and such reliance would be conclusively presumed to have been done in good faith.

Trial Court Ruling
The Court of Chancery determined that the defendants had satisfied the conditions in the agreement that provided insulation from claims, and held that the presumption of good faith protected those who were parties to the agreement.

The trial court also held that the implied covenant claim only bound the parties to the partnership contract.

Supreme Court Analysis

The Delaware Supreme Court found fault with that aspect of the Chancery opinion that determined that Morgan Stanley had opined on the fairness of the 2009 Sale, but Delaware’s high court read Morgan Stanley’s opinion to refer to the total consideration for a combined 2009 Sale as well as a separate sale, as opposed to the consideration allocable to the 2009 Sale only.

Delaware’s high court distinguished its recent opinion in Norton v. K-Sea Transportation Partners LP, highlighted here on these pages, because in that case the banker’s opinion indirectly addressed the fairness of consideration at issue and the plaintiffs conceded fair consideration.  In contrast, the Morgan Stanley 2009 opinion in this case did not address the consideration that the limited partners received in the 2009 Sale separately, but instead addressed two separate transactions together as a whole.  See footnote 29.

At footnote 31, Delaware’s high court explains why it rejected the reasoning of the Court of Chancery in its dismissal of the claim based on a breach of the implied covenant of good faith and fair dealing in connection with Section 17-1101(d).

Supreme Court Approach to the Core Issues

The Supreme Court distilled the plethora of legal disputes and focused on two core issues as being dispositive of the appeal.  The first is whether the claims of liability are precluded by the “conclusive presumption of good faith” in Section 7.10(b) of the agreement.  If that section does not bar a claim under the implied covenant, then that provision does not preclude judicial review.

Because the Delaware Supreme Court determined that the “conclusive presumption” does not bar those claims, the second issue was described as follows:  whether the complaint adequately pled the breach of the implied covenant of good faith and fair dealing.  The Delaware Supreme Court concluded independently that both the 2009 Sale and the 2010 Merger were subject to a well pled breach of the implied covenant.

Due to the Supreme Court finding that the foregoing claims should not have been dismissed, on remand a third set of issues that the trial court did not raise were ordered to be addressed on remand:  which defendants, if any, other than the general partner are subject to secondary liability for tortious interference or for aiding and abetting a breach of contract.

Standard of Review

The standard of review on appeal of the dismissal of a complaint under Court of Chancery Rule 12(b)(6) is de novo.

Appellate Reasoning

The opinion explained why the presumption of good faith in the agreement did not bar a claim for breach of the implied covenant of good faith and fair dealing.

The high court found that the:

“flaw in the [trial] court’s reasoning stems from a decision by the LPA’s drafters to define a contractual fiduciary duty in terms of “good faith” – – a term that is also and separately a component of the “implied covenant of good faith and fair dealing.”

Although that term is common, the LPA’s contractual fiduciary duty describes a concept of “good faith” very different from the good faith addressed by the implied covenant.

The court adopted the explanation in a separate Chancery ruling that explained the difference between the common law fiduciary duty concept or a contractual fiduciary duty concept, as it differs from the implied covenant of good faith and fair dealing.  See Slip op. at 32-34 and footnote 47.  The block quote of almost two pages explains the importance of the temporal distinction between the contractual fiduciary duty and the implied covenant.

The focus of a fiduciary duty analysis is the action at the time that the wrong took place.  By contrast, the focus of an analysis under the implied covenant, is what the intent of the parties was at the time that the contract was formed, which is often many years prior to the alleged wrong.  See footnote 48.

Footnote 48 also explains that a contractual provision of any type could never properly eliminate the implied covenant, contrary to what was implied by the Court of Chancery in this matter.  The Supreme Court emphasized that there could be no elimination of the implied covenant, even on a de facto basis through a conclusive presumption, and nothing in the Supreme Court’s opinion of Nemec v. Shrader should be interpreted differently.

The high court provided several hypothetical examples of why the implied covenant cannot be “contracted away,” and that no provision in an agreement could bar a claim for arbitrary and unreasonable use of discretion that would be a breach of the implied covenant.

The high court did note, however, that it is well settled in Delaware that the implied covenant cannot apply to non-parties to a contract.  See footnote 53.

The high court also held that an implied covenant claim can still be stated even where, as here, the defendant allegedly attempted to satisfy its contractual obligations, within a conclusive presumption provision, by relying on a fairness opinion that did not value the consideration that was actually received by the LP unitholders.

In this case, the court reasoned that it could “confidently conclude” that had the parties addressed the issue at the time of contracting, they would have agreed that any fairness opinion must address whether the consideration actually received was fair in order to satisfy the contractually defined duty, which was the good faith component of the contractual fiduciary duty defined in Section 7.9(b).  The court reasoned that relying on an unresponsive fairness opinion to engage in a manifestly unfair transaction in a manner that would be conclusively presumed to satisfy a contractual standard, is “the type of arbitrary, unreasonable conduct that the implied covenant prohibits.”  (Compare: Norton v. K-Sea Transportation Partners L.P. which did not involve claims that the fairness opinion did not state that the merger was fair, nor did that plaintiff allege that the fairness opinion was flawed.)

The court also reasoned that the implied covenant supported the view that the parties:

“would certainly have agreed, at the time of contracting, that any fairness opinion contemplated by that provision [Section 7.10(b)] would address the value of derivative claims where (as here) terminating those claims was a principal purpose of a merger.  Therefore, Gerber has sufficiently pled that Enterprise Products GP breached the implied covenant in the course of taking advantage of Section 7.10(b)’s conclusive presumption.”

The court also independently determined, based on the allegations in the complaint, that in connection with the 2010 Merger, although the agreement does not expressly forbid the general partner from acting in the way that it did when effecting a merger, the court reasoned that it “is reasonably inferable that, had the parties focused on that question at the time of contracting, they would have proscribed such conduct.”  Thus, the court remanded.

RAA Management, LLC v. Savage Sports Holdings, Inc., No. 577, 2011 (Del. May 18, 2012).

Issue Addressed: Whether a disclaimer in a non-disclosure agreement barred claims for fraud by a potential buyer of a business. Short Answer: Yes.

Supplement: Professor Bainbridge has a post that addresses this issue in his usual scholarly manner and also links to this summary by your truly. 

Background Facts

This appeal involved RAA Management, LLC which was one of several bidders for the defendant, Savage Sports Holdings, Inc.  A precondition to Savage providing RAA with confidential information about the company was that RAA enter into a non-disclosure agreement (“NDA”).  RAA terminated negotiations with Savage before the parties executed a final sale agreement.  RAA claimed $1.2 million that it spent in due diligence and negotiation costs, and that were incurred prior to RAA becoming aware of “significant unrecorded liabilities or claims against Savage,” that Savage did not disclose.  The trial court dismissed the claims.

Analysis

The Supreme Court assumed that New York would apply, even though the trial court did not specify whether Delaware law or New York law applied, but the High Court of Delaware concluded that “the outcome would be the same under Delaware law.”

The Court cited to two prior decisions by the Delaware Court of Chancery that were “virtually identical to the issues in the present case. In both cases, the Court of Chancery found the disclaimer language at issue to be unambiguous under both New York and Delaware law.”  See Great Lakes Chemical Corp. v. Pharmacia Corp., 788 A.2d 544 (Del. Ch. 2001); In re IBP, Inc. S’holders Litig., 789 A.2d 14 (Del. Ch. 2001).

In the Great Lakes case, the Court of Chancery held that several clauses in a purchase agreement between two sophisticated corporations precluded the buyer from asserting any fraud claims against the seller under Delaware law.  That case involved an NDA almost identical to the one in the instant appeal, and prevented any liability resulting from any information made available to the buyer or any representations as to the accuracy or completeness of any information made in connection with an investigation or due diligence of the company.  The IBP, Inc. case also barred fraud claims due to a disclaimer in an NDA.  That case dismissed claims that the seller lied during the due diligence discussions about the current sales performance of the target.

The Court also referred to Delaware case law involving the following principle:  “Contract interpretation that adds a limitation not found in the plain language of the contract is untenable.”  See fn. 4.

Public Policy Supports Disclaimers for Statements Outside Contract

The Court also rejected the public policy arguments.  The only case cited in support of the appellant’s public policy arguments was Abry Partners V, L.P. v. F&W Acquisition LLC, 891 A.2d 1032 (Del. Ch. 2006).  The Abry Partners case explained the public policy of Delaware that favors enforcing contractually binding, written disclaimers of reliance on representations outside of a final sales agreement.  The decision in that case emphasized that a contract between sophisticated parties would be upheld if it contains a provision that explicitly disclaims reliance upon representations outside of a contract.

The Abry Partners Court distinguished fraud claims based on representations made outside of a merger agreement – which can be disclaimed through nonreliance language – –  with fraud claims based on “false representations of fact made within the contract itself” – –  which cannot be disclaimed.  See fn. 25 and 26.

The Court emphasized that Abry Partners accurately states Delaware law and explains Delaware’s public policy in favor on enforcing contractually binding written disclaimers of reliance on representations outside of a final agreement of sale or merger.

The Court also emphasized that the purpose of a confidentiality agreement is to promote and facilitate such precontractual negotiations; and nonreliance clauses in a confidentiality agreement are intended to limit or eliminate liability from misrepresentations during the due diligence process.

The Court opined that:  “The efficient operation of capital markets is dependent upon the uniform interpretation and application of the same language and contracts or other documents . . . [T]he reasonable commercial expectations of the parties as set forth in a nonreliance disclaimer clauses . . . must be enfoced.”

Practice Comments

Those involved in the drafting of nonreliance clauses and those who seek to enforce or defend agreements with disclaimers designed to prevent claims of misrepresentation based on statements or omissions outside of a contract, need to read this opinion.

Seven Investments, LLC v. AD Capital, LLC, C.A. No. 6449-VCL (Del. Ch. Nov. 21, 2011), read opinion here.

Issue Addressed: Whether a release agreement previously signed among the parties served to preclude the claims presented in this case.

Short Answer: Yes

Very Short Overview
This relatively concise decision of the Court of Chancery provides an excellent primer on the “law of releases” and in what types of situations the terms of releases in settlement agreements will – – or will not allow one of the parties to the release to bring claims that would otherwise be barred by the release. In addition to the illuminating amplifications, especially of releases in general, and their legal effect, the opinion refers to a Delaware Supreme Court decision that is one of those rare cases which define the fraud exception to allow claims otherwise covered by a release. See E.I. duPont Nemours & Co. v. Florida Evergreen Foliage, 744 A.2d 457, 461 (Del. 1999). The Court of Chancery cabined the DuPont decision to the unusual facts of that case where a cause of action for fraud in the inducement could void a release. See generally Abry Partners V, L.P. v. F&W Acquisitions LLC, 891 A.2d 1032, 1062 (Del. Ch. 2006) (noting in the context of exclusive remedy provision in an agreement that “permitting a party to seek a relief that it has contractually promised not to pursue creates the possibility that buyers will face erroneous liability and uncompensated costs.”)

Noteworthy about this decision is the discussion at footnote 2 which discusses cases from other jurisdictions that impose different and often higher standards when a fiduciary negotiates a release. The Court did not need to address that issue in this case and confirmed that it did not “intimate any opinion on that most interesting question.”

NACCO Industries Inc. v. Applica Incorporated, No. 2541-VCL (Del. Ch. Dec. 22, 2009), read opinion here

This 63-page Delaware Court of Chancery decision rules on a Motion to Dismiss in connection with claims for damages arising out of a failed acquisition attempt and a terminated Merger Agreement between Applica Incorporated and NACCO Industries, Inc. The Court dismissed the claims for breach of the implied covenant of good faith and fair dealing, aiding and abetting a breach of fiduciary duty and equitable fraud. The Court allowed to proceed to trial claims for breach of contact, tortious interference with contract, fraud (faulty disclosures in SEC filings) and civil conspiracy.

Brief Factual Background

Applica initially entered into a Merger Agreement with NACCO but Applica terminated that agreement and agreed to be acquired by affiliates of Harbert Management Corporation. After a bidding contest, NACCO lost, and now seeks damages and other relief relating to that unsuccessful bidding contest. Harbert Management Corporation is an investment manager that oversees a hedge fund complex. The complaint names various entities affiliated with Harbert that were involved in the transaction and because many of those funds operate under the name “Harbinger,” the Court refers to those affiliated entities collectively as Harbinger. The Harbinger principals were previously dismissed from the suit for lack of personal jurisdiction. Applica markets, distributes and sells small household appliances. Prior to being taken private by Harbinger, the common stock of Applica traded on the New York Stock Exchange. NACCO is a holding company whose shares trade on the NYSE as well.

In 2005, NACCO approached Applica about a strategic transaction with Hamilton Beach. The parties signed a Non-Disclosure Agreement and exchanged confidential information but Applica broke off talks, inviting NACCO to re-approach in early 2006. In early 2006 Applica and NACCO began merger discussions anew and NACCO agreed to standstill provision that limited ability to act unilaterally to acquire Applica. About seven months later, when NACCO found itself in a bidding contest for Applica, the consequences of agreeing to the Standstill Agreement proved critical, because NACCO at the time was competing against Harbinger who was not similarly restricted, and had used its freedom to acquire a large block of Applica stock. In September 2006, Harbinger announced a bid to acquire all of the Applica shares it did not yet own.

Despite the Non-Disclosure Agreement that NACCO and Applica had signed, NACCO alleges that Applica disclosed confidential information to Harbinger to assist it in its acquisition of Applica. NACCO alleges that because Applica senior executives were at risk of losing their jobs in a deal with NACCO and Hamilton Beach, Applica insiders favored a Harbinger deal as a financial buyer likely to retain them.

Harbinger made several Schedule 13D filings in which it failed to disclose or inaccurately disclose its intentions with respect to its increasing purchases of Applica stock to a nearly 40% stake as well as its outgoing communication from Applica management and its communications with Applica management to avoid the restrictions of the Florida Control Shares Act that would have prevented Harbinger from voting its shares due to its newly acquired percentage of ownership. Although its August 2006 Schedule 13 filings continued to state that Harbinger was holding its shares for investment purposes without any plan to control Applica, on September 14, 2006, Harbinger offered to acquire all of the outstanding shares of Applica that Harbinger did not already own for $6 a share and at the same time amended its prior Schedule 13 forms. In October 2006, Harbinger again amended its Schedule 13D filings to state that as of September 14, 2006, its intent was to acquire all of Applica’s shares.

On September 15, 2006, Applica informed NACCO that the Harbinger bid was likely to be a superior proposal and engaged in merger discussions with Applica which was an exception to the “no-shop provision” in the Merger Agreement with NACCO but which otherwise limited the ability of Applica to explore competing transactions.

On October 10, 2006, Applica notified NACCO that it was terminating its Merger Agreement and would enter into a Merger Agreement with Harbinger. NACCO asserted that Applica had breached the no-shop provision and had failed to promptly advise of developments with Harbinger and that it had been mislead by the statements in the Schedule 13D filings of Harbinger.
Applica paid NACCO a $4 million termination fee and $2 million in expense reimbursement.
On November 2, 2006 Applica filed a preliminary proxy statement to solicit proxies in favor of the merger with Harbinger. The background section of the disclosures were much different from the disclosures in the Schedule 13D filings of Harbinger.

On November 13, 2006, NACCO filed this action against Applica and Harbinger seeking, among other things, a decree of specific performance and an order enjoining the Harbinger merger. NACCO sought expedited discovery in a trial but was informed that the Court’s calendar could not accommodate a full trial prior to the anticipated closing of the merger. NACCO then moved for a preliminary injunction but after an exchange of documents withdrew its injunction application in December.

A separate action filed by NACCO in federal court in Ohio also sought injunctive relief, but that new request for injunctive relief was denied and NACCO dismissed that federal case without prejudice. Between the end of December 2006 and January 2007, NACCO and Harbinger bid against each other for Applica. NACCO explained that it was at a disadvantage because while it was subject to a Standstill Agreement, Harbinger had acquired a 40% block of Applica’s stock. Thus, while Harbinger was effectively only bidding for 60% of Applica, NACCO was bidding for the entire company. That is, for every dollar that NACCO offered, Harbinger only had to match with sixty cents. On January 24, 2007, the stockholders of Applica approved the merger with Harbinger and NACCO terminated its offer.

Shortly after the stockholder approval of the merger with Harbinger, Applica and Salton entered into a Merger Agreement based on the efforts of Harbinger. In December 2007, the transaction closed and Harbinger owned 92% of the combined company.
In October 2007, NACCO amended its complaint and the individual defendants sought jurisdictional discovery. In February 2008, a Motion to Amend the Second Amended Complaint was filed and in May 2008 the motion was granted. In December of 2008, after Motions to Compel and jurisdictional discovery, the parties entered into a stipulation regarding jurisdictional facts. In the summer of 2008, the Court ruled that personal jurisdiction could not be obtained over the individual defendants.

Overview of Legal Analysis

 I. Breach of Contract

After discussing in great detail the references to the motive of the senior managers of Applica to favor the Harbinger deal which would allow them to keep their jobs, and the timing of confidential information that was obtained by Harbinger during a period when the Confidentiality Agreement applied, the Court concluded that at the early pleading stage it would be appropriate to draw reasonable inferences in favor of the plaintiff as opposed to weighing competing inferences that might later be determined to have legitimate explanations.

The Court also emphatically rejected the argument that there were “no damages” because NACCO subsequently lost the bidding war. The Court reasoned that:

“If embraced as grounds for a pleadings-stage dismissal, the defendants’ theory would have serious adverse ramifications for merger and acquisitions practice and for our capital markets. Parties bargain for provisions in acquisition agreements because those provisions mean something. Bidders in particular secure rights under acquisition agreements to protect themselves against being used as a stalking horse and as consideration for making target-specific investments of time and resources in particular acquisitions. Target entities secure important rights as well. It is critical to our law that those bargained-for rights be enforced, both through equitable remedies such as injunctive relief and specific performance, and, in the appropriate case, through monetary remedies including awards of damages.”

Although it received a bargained-for termination fee as is customary in merger agreements, the right to terminate the agreement by Applica without further liability was dependant upon Applica complying with its other obligations under the agreement.

 II. The Implied Covenant of Good Faith and Fair Dealing

The Court cited to well established Delaware law that when the subject at issue is expressly covered by the contract, a claim for the implied covenant of good faith and fair dealing does not apply. In this case, the merger agreement included detailed provisions governing the issues that have been raised; and the express terms that are claimed to have been violated leave no room for the implied covenant.

 IIII. Fraud

In Court IV, NACCO asserted a claim for common law fraud against Harbinger. The fraud claim turns exclusively on the statements that Harbinger made in its Section 13 filings between March and August of 2006.

  1. State v. Federal Jurisdiction

The fraud (faulty disclosure) claim raises a jurisdictional issue of whether a Delaware Court can provide a common law fraud remedy for false statements in a filing required by the Exchange Act. The Delaware Supreme Court has held that such a remedy exists and that the Court of Chancery has the ability to enforce such a remedy where the Delaware entity has been accused of fraud. See Rossdeutscher v. Viacom, Inc., 768 A.2d 8 (Del. 2001). See also 15 U.S.C. Section 78aa and 78bb.

In that Viacom case, Delaware’s High Court explained that the “federal statutory remedies of the Act over which the federal courts have exclusive jurisdiction are intended to coexist with claims based on state law and not preempt them.” Id. at 17. The Court also discussed and analyzed multiple decisions of the United States Supreme Court and other federal courts to support its ruling on this issue.

The Court of Chancery engaged in a thorough review of the applicable law on this jurisdictional issue and concluded that “the extent to which a state law claim necessarily raises a federal issue is inherently a question of degree, requiring a pragmatic judgment based on the particulars of the individual case.” Referring to multiple decisions regarding removal of cases from state court to federal court, the Court of Chancery reasoned that Section 27 of the Exchange Act does not confer exclusive jurisdiction on the federal courts to hear common law fraud claims based on statements in federal securities filings. The Court referred to multiple federal decisions in which plaintiffs have asserted both securities fraud under Rule 10b-5 or another federal provision and common law claims for fraud and misrepresentation.

Those decisions consistently exercised federal jurisdiction over the state law claim under a theory of supplemental jurisdiction (or its predecessors pendent and ancillary jurisdiction), not federal question jurisdictional under 28 U.S.C. Section 1331, nor exclusive Exchange Act jurisdiction under Section 27. This was compared to a claim to enforce Section 13 of the Exchange Act or asserting a claim for violation of Section 13 regarding false statements made in a Schedule 13D filings with related fraud claims under state law, a case in which the Court of Chancery would not have jurisdiction and which could only be heard in federal court. (citing Lowenschuss v. Options Clearing Corp., 1989 WL 155767, at * 2-3 (Del. Ch. Dec. 21, 1989) and Diceon Elecs., Inc. v. Calvary Partners, L.P., 772 F.Supp. 859 (D.Del. 1991)).

By contrast, the Court explained that “if a Delaware entity engages in fraud or is used as part of a fraudulent scheme, that entity should expect that it can be held to account in the Delaware Courts.” (Slip op. at 42.)

  2. Element of Falsity

For the pleaded fraud claim, NACCO was required to allege a fraudulent misrepresentation which Court of Chancery Rule 9(b) requires to be plead with particularity so that there is sufficient detail to apprise a defendant of the basis of the claim, although the state of mind of the defendant, including its intent, need not be plead with particularity. The pleading requirements also take into account whether “the facts lie more in the knowledge of the opposing parties than of the pleading party.” The Court also referred to the Restatement (Second) of Torts, Section 530, for the established law that “permits a misrepresentation regarding intent to form the basis for a fraud claim,” specifically quoting Section 530 as follows: “a representation of the maker’s own intention to do or not to do a particular thing is fraudulent if he does not have that intention.”

In sum, reading the complaint as a whole, the Court found that there were sufficient detailed allegations to plead that the disclosures of Harbinger in its Schedule 13 filings were false.

The Court also rejected an argument by Harbinger that in the “community of hedge funds” who frequently file Schedule 13Ds that one need not disclose any intent other than investment intent until one actually makes a bid. The Court observed that Harbinger could not offer legal support for their view but rather the recent persuasive rejection of that self-serving and formulistic interpretation was noted in the case of CSX Corp. v. Children’s Fund Mgmt. (UK) LLP, 562 F.Supp. 2d. 511 (S.D.N.Y. 2008), aff’d, 292 F.App’x 133 (2d. Cir. 2008)

  3. Reliance and Materiality

The Court noted that a false statement is not a strict liability offense but rather to plead a claim of fraud, one must have the “intent to induce the plaintiff to act or refrain from acting” and the plaintiff must in fact have acted or not acted “in justifiable reliance on the representation.” Of equal importance is that the false statement must have been material. Especially in the context of a fraud claim based on a statement in a filing required the Exchange Act, the reliance inquiry plays an important role to legitimize a Delaware Court in providing a remedy. Despite the “unusual and extreme facts” plead in the complaint, the Court admits that it is “frankly troubled by the reliance inquiry” and views it as a “close call.”

   4. Causally-Related Damages

The Court emphasized that to be actionable, a false statement must cause harm and that the necessary causal connection has two parts. First, the false statement must be a factual cause of the harm in the sense that the harm would not have occurred but for the false statement. Second, the false statement must be a legal cause of the harm, meaning that the false statement must be a sufficiently significant cause of the harm to impose liability. (citing Restatement (Second) of Torts, Section 548A, cmt. a-b.) As with the element of reliance, the Court viewed this question of causation of damages as a close one but at the Motion to Dismiss stage, similar to the reasoning on the reliance argument, the Court concluded that NACCO had sufficiently plead that its harm was causally connected to the false disclosures of Harbinger. In the reliance analysis, the Court was concerned with imposing an unfair burden on NACCO to prove “what might have happened” or to penalize a victim in insulating a wrongdoer who argues that the victim “should have known better.” (Slip op. at 54.)

IV. Equitable Fraud

Regarding Count V, in connection with the claim for equitable fraud, because NACCO is a sophisticated party and none of the defendants occupied a special relationship towards NACCO, nothing about the case suggests any equity that has traditionally moved this Court to relax the pleading requirements for fraud and therefore equitable fraud is not appropriately invoked in this case.

V. Count III for Tortious Interference of Contract

The Court declined to dismiss Count III for the tort of interference with contractual relations, which is intended to protect the economic interest of a promisee in the performance of a contract by making actionable any “improper” intentional interference with the performance of the promisor. The elements of a claim for tortious interference with contract are: (1) a contract; (2) about which defendant knew; (3) an intentional act that is a significant factor in causing the breach of such contract; (4) without justification; and (5) which causes injury.

In this case, based on the breach of contract analysis performed by the Court regarding Count I, the complaint adequately alleges that Harbinger knew about the no-shop clause, but nevertheless engaged in contacts and communications that violated those clauses. Elements three and four were also covered in the breach of contract analysis.

Similar to the related but different claim for tortious interference with prospective business relations, the Court of Chancery has explained that “claims for unfair competition and tortious interference must necessarily be balanced against a party’s legitimate right to compete,” but misrepresentations of fact “are not legitimate vehicles of competition.” (citing Agilent Technologies, Inc. v. Kirkland, 2009 WL 119865, at * 8 (Del. Ch. Jan. 20, 2009)).

The Court also cited to another decision in which the defendant was held liable for tortious interference where that defendant obtained an unfair advantage by using confidential information it had obtained from other defendants in violation of contractual agreements. See Cura Fin. Servs. v. Elec. Payment Exch., Inc., 2001 WL 1334188, at *18 (Del. Ch. Oct. 22, 2001).

VI. Count VI Regarding Aiding and Abetting a Breach of Fiduciary Duty

This claim was abandoned during briefing.

VII. Claim for Civil Conspiracy in Count VII

The elements of a claim for civil conspiracy are: (1) a confederation or combination of two or more persons; (2) an unlawful act done in furtherance of the conspiracy; and, (3) actual damage. It is well established that each conspirator is jointly and severally liable for the acts of co-conspirators committed in furtherance of the conspiracy.

It is essential that there be an underlying wrongful act, such as a tort or a statutory violation, but a breach of contract is not an underlying wrong that can give rise to a civil conspiracy claim. (citing Kuroda v. SPJS Holdings, LLC, 971 A.2d 872, 892 (Del. Ch. 2009)).

The Court explained that Delaware “recognizes the concept of efficient breach” (citing Allied Capital Corp. v. GC-Sun Holdings, L.P., 910 A.2d 1020, 1039 (Del. Ch. 2006)). The Court added that Delaware law generally elevates contract law over tort to allow parties to order their affairs and bargain for specific results, to the point where Delaware law enforces contractual provisions that eliminate the possibility of any tort liability short of actual fraud based on explicit written contractual representations (citing Abry Partners, 891 A.2d at 1061-64).

Thus, a claim of conspiracy to commit tortuous interference against the party to a contract would undercut the foregoing principles and replace the predictability of the parties’ agreement with a far less certain judicially created tort remedy; and recognizing such a “round-about claim” would circumvent the limitations on tort liability that are a fundamental aspect of Delaware law. Therefore, to the extent that Count VII asserts that Applica and Harbinger conspired to breach the Merger Agreement, the Court dismisses that claim as well as the claim that there is liability in tort for civil conspiracy to engage in tortious interference with that agreement.

However, NACCO argues that fraud provides the necessary underlying wrong and that Applica conspired with Harbinger to engage in fraud for which they should be liable. As previously explained, because there is a sufficient basis for the fraud claim, and for the foregoing reasons, there is a sufficient basis to state a claim for civil conspiracy based on fraud.

Conclusion

In conclusion, the Court required the parties to provide a scheduling order that would bring the matter to trial within 12 months. The Court also emphasized that this is a “pleadings-stage decision” and whether NACCO ultimately prevails and obtains a remedy will depend on the evidence presented, any defenses, and the ultimate equities of the case.

 

Choice Hotels International, Inc. v. Columbus-Hunt Park Dr. Bnk Investors, L.L.C., No. 4353-VCP (Del. Ch. Oct. 15, 2009), read corrected opinion here (and letter accompanying corrected version here.) This Chancery Court decision involves a dispute pursuant to Section 18-110 of the Delaware LLC Act regarding who the proper manager of the LLC is (analogous to DGCL Section 225), but before the Court could address those substantive issues, it needed to address a procedural entanglement that arose due to the parties having other litigation pending among them in another jurisdiction.

Holding

This Chancery Court opinion granted a Motion to Stay this Delaware dispute regarding the governance of an LLC, in order to allow a previously filed Maryland lawsuit between the parties to proceed.

Compare this result with the very recent decision in another case by the Delaware Court of Chancery that denied a Motion to Dismiss or Stay a Delaware suit despite pending litigation between the parties elsewhere, in the matter styled: Total Holdings USA, Inc. v. Curran Composites, Inc., No. 4494-VCS (Del. Ch. Oct. 9, 2009), read opinion here. A very short overview of the Total Holdings case is available on this blog here.

Overview

In this Choice Hotels decision, the Court provides an extensive factual background and procedural history of the competing lawsuits in which the parties are involved in different states. Within the 34-page opinion, the Court provides a “mini-treatise" on the various rules and policy reasons, as well as court decisions and standards, that are applied in Delaware to determine whether a lawsuit in Delaware will be stayed in favor of litigation pending in other states between the parties, or whether the Delaware court will hear the case before it instead of favoring a similar case proceeding between the parties in another jurisdiction.

Discussion

This case and the Total Holdings case, supra, decided within a week of each other by two different members of the Court of Chancery, involving completely different factual and procedural circumstances, provide a juxtaposition of two different results reached by courts who had to decide which competing similar lawsuits would proceed. Admittedly, these two recent Chancery decisions involved much different sets of circumstances and the legal issues were not the same, but the common thread between them was that a decision had to be made about whether a Delaware case would be stayed or allowed to proceed in light of a related case pending elsewhere.

In Total Holdings, the Court of Chancery denied a Motion to Stay or Dismiss, but in the Choice Hotels case the Court granted it. This is an indication that there is no simple “bright line test” that would allow one to easily predict when a case will be stayed or dismissed in favor of similar or related litigation between similar or identical parties, pending simultaneously in more than one forum. In part this lack of predictability is due to the intensely factual nature of the analysis. In one sense, this Choice Hotels decision by the Court of Chancery can be simplistically summarized by saying that "the Court applied the ‘first-filed rule’ to allow the lawsuit between the parties that was filed first in another state to proceed and thus stayed the subsequently filed Delaware lawsuit.” However, that would not be a meaningful assessment of the somewhat complex factual and procedural history involved with the very nuanced legal principles that the Court wrestled with in this case.

This short blog overview assumes some familiarity with the first-filed rule–also known as the McWane doctrine.

Special Consideration Given To Summary Proceedings Even When Delaware is Second Suit.

The McWane doctrine and the forum non conveniens analysis are both tempered by the competing policy priority that is enjoyed by lawsuits that are given statutory status as “summary proceedings” such as actions filed under 8 Del. C. Section 225 or 6 Del.C. Section 18-110, both of which provide a procedure for a swift resolution of cases involving a contest for control to determine who the rightful directors of a corporation are, or who the valid managers are of an LLC.

Specifically, the Court recognized that :

“in cases where rapid resolution of a corporate governance dispute is needed and a non-Delaware court is not in a position to provide expedited adjudication and prompt justice, the courts typically will deny a Motion to Stay the Section 225 or Section 18-110 action in Delaware because the policies underlying those sections take precedence over the policies underlying McWane." (See footnote 41.)

However, the Court cited cases at footnotes 42 and 45 to acknowledge that the policies underlying Section 225 will not invariably compel the denial of a Motion to Stay in every situation, but rather when faced with a Motion to Stay a summary  action, the Court must balance the McWane policies of comity in promoting the efficient administration of justice against the policies underlying the summary nature of the Delaware action.

The Court applied the familiar McWane factors to this case and also discussed the applicability of the forum non conveniens standard which is triggered when it is unclear whether a related case was filed first. It also may be applicable when multiple actions are contemporaneously filed. 

Court Rejects Ad Hominem Attack

In footnote 27, the Court addresses a matter of interest far beyond this case. The Court rejected an ad hominem attack that Choice Hotels mounted against the principal of the defendant, based on prior criticism in another case by another member of the Court of Chancery who lambasted the party as not being trustworthy. This argument used up about one third of the plaintiff’s brief according to the Court’s estimate. Choice Hotels tried to use that prior expression of judicial disapproval, unsuccessfully, based on the maxim of falsus in uno, falsus in omnibus. The Court rejected the arguments because regardless of the condemnation in the prior case of his truthfulness, there were no specific facts averred that were relevant to the instant action that would support drawing such a negative reference from the past conduct of the defendant’s principal.

Excerpts of Court’s Reasoning

Among the McWane factors applied by the Court was whether "prompt and complete justice" was availabe in the Maryland courts where the other case(s) were pending.  Extensive review of the various Maryland case management options revealed that Maryland has a type of  "business court" that the Chancery Court found:  "…may not be as quick as a summary proceeding under Section 18-110, but it still appears capable of providing an efficient and reasonably prompt resolution of the business entity issues raised  by [the plaintiff’] in Delaware."

The Court’s reasoning to support its grant of the motion to stay was buttressed by its observation that: "If I refuse to stay the Delaware Action, it seems quite possible that overlapping litigation will proceed on two fronts."

In its concluding rationale, the Court explained that the policy animating the McWane doctrine also applies to "a single party filing two or more actions in diverse forums and thereby forcing the nonfiling party to expand its efforts significantly."

Court Rejects Argument that Fraud Claims Are Waivable by Agreement

As an aside to its analysis, the Court also addressed a important issue that has broad application in many cases. The plaintiff in this Delaware case asserted that a waiver that the defendant in the Delaware case signed would prevent him from raising defenses to a certain agreement. However, the Court would not agree that Delaware law prevents an intentional fraud defense to enforcement of an agreement, relying on Abry Partners V, L.P v. F & W Acq. LLC, 891 A.2d 1032, 1035 (Del Ch. 2006). The Court quoted from Abry, a case that involved two sophisticated parties arguing over a stock purchase agreement, and which addressed whether public policy would allow enforcement of a provision that limited liability for misrepresentation of fact:

… when a seller intentionally misrepresents a fact embodied in a contract–that is, when a seller lies–public policy will not permit a contractual provision to limit the remedy of the buyer to a capped damage claim.

Id.

Postscript

On a more macroeconomic level beyond the concerns of this case, it is also noteworthy to mention in passing that at least one corporate law scholar has suggested that Delaware Courts should consider refraining from addressing certain cases that arise in connection with the threat of increasing federal jurisdiction over corporate law–issues which are in no way raised in this case, but some of the legitimate procedural and policy reasons on which a Delaware court may rely for refraining to consider a case before it, are referenced in this case. See footnote 28 citing In Re Bear Stearns Cos. S’holder Litig., 2008 WL 959992 (Del. Ch. April 9, 2008). See generally Professor Edward Rock’s recent lecture, here, addressing the broader policy issues (not applicable to the facts of this case), regarding when it might be preferable for a Delaware court to refrain from hearing a case before it. Although the good professor referred in his recent presentation primarily to the federal government being an indispensable party (as a majority shareholder) under Rule 19, some of the reasons for abstaining in this opinion may be generally relevant to his conceptual discussion.

 

 

 

 

 In Pharmathene, Inc. v. SIGA Technologies, Inc., 2008 WL 151855 (Del. Ch., Jan. 16, 2008), read opinion here, the Chancery Court addressed several key issues of great interest to those involved in business litigation–and civil litigation in general. The background of this case involved various documents entered into by two companies, some of which were formal and complete and others that were not, but all of which were initially intended to lead to additional collaboration that never happened.

Here is a quick list of the important issues decided, and statements of Delaware law explained,  in what the court describes as "essentially an action for breach of contract".

1) In a Motion to Dismiss under Rule 12(b)(6), the court will not consider matters outside the pleadings and thus, refused to consider an affidavit submitted in opposition to the motion. The exception to this rule, that did not apply here, is when documents are integral to the claim, or are referred to in the complaint, or when not presented to prove the truth of their contents.

2) Delaware has a specific statute, Section 2708 of Title 6 of the Delaware Code, that authorizes the court to uphold a choice of law clause in a contract, despite contrary conflicts of law principles, if the contract involves more than $100,000. Such a provision is itself presumed to be a significant, material and reasonable relationship with the state. See Section 187(1) of the Restatement, Second, of Conflicts of Laws.

3) Faced with three separate agreements, one without a choice of law provision, one with a New York choice of law clause, and one choosing Delaware law, the court chose Delaware law to apply for deciding the Motion to Dismiss, for several reasons. For example, it was the last agreement signed by the parties and covered the broadest scope of matters compared with the other two. See also, the recent Chancery Court decision in Abry,  891 A.2d 1032, 1048 n.25 (Del. Ch., 2006), discussing the likely preference of a reasonable businessperson to have one state’s law apply to the same basic dispute involving various agreements.

4)  Is an "agreement to agree" enforceable"? The parties entered into an agreement that provided for them to "negotiate in good faith with the intention of executing a definitive License Agreement in accordance with the terms set forth in a [term sheet, that included a footer that said it was ‘non-binding’]." The court found too many ambiguities to grant a Motion to Dismiss.

 The court cited to Delaware cases  holding that "a contract to make a contract may be specifically enforced if it contains all of the material and essential terms to be incorporated into the final contract and those terms are definite and certain." See footnotes 49 and 50. The court noted that even if the prerequisites are satisfied, specific performance is a discretionary form of  relief. The factual issues made it premature to dismiss this claim at this preliminary stage of the proceedings.

5) The claim for breaching a duty to "negotiate in good faith a definitive license agreement in accordance with the …[term sheet] " was also allowed to proceed to trial based on the court’s finding that it could conceivably be proven that best efforts were not used to conclude a license agreement.

 

 

Prof. Larry Ribstein has a thoughtful post on a recent Chancery decision discussing the enforceability of a contract that allows misrepresentations. Abry Partners V, L.P. v. F & W Acquisition LLC, 2006 WL 358236 (Del. Ch. 2/14/06), download file. Here is the link to Larry’s post:
Ideoblog: Should a court enforce a contract that permits lying?
The above opinion has a good analysis of integration clauses and how they interface with claims of fraud, as well as the need for a clear anti-reliance clause (see page 46 and cite to Kronenberg, 872 A.2d. 568 (Del. Ch. 2004)). Also included are helpful discussions on the comparison of fraud as a tort as opposed to fraud as a contract defense. (See footnote 26). Footnote 46 has a discussion of basis for a claim of fraudulent inducement. Also referred to is 6 Del. C. Section 2708 which allows parties to choose Delaware as the governing law in a contract.