One of my regular ethics columns for the national publication of the American Inns of Court, The Bencher, referred to two decisions that addressed the conduct of attorneys during a deposition and in written arguments to the court. The article is available here.
Phillips v. Firehouse Gallery LLC, C.A. No. 3644-VCL (Del. Ch. Aug. 9, 2010), read letter decision here.
It remains one of the more unpleasant aspects of a litigator’s life when "what should be a routine discovery matter" such as scheduling a deposition, becomes an impasse. Often the Court is upset at both parties for not working out the matter on their own, and takes the view of "a pox on both your houses"–even if it is only one party’s fault. In this decision the Court "took sides" and determined that the problem was the fault of one party.
Referring to Court of Chancery Rule 30(b)(1) and the case of La. Mun. Police Empl. Ret. Sys. v. Fertitta, 2009 WL 3806216, at * 1 (Del. Ch. Oct. 27, 2009), regarding the requirement of reasonable notice that needs to be provided in connection with taking a deposition, the Court recognized the practice of noticing a deposition with “nominal dates” in the nature of a placeholder which is later finalized for a mutually convenient time, date and place when the deposition will go forward. This short letter decision addressed the situation where the parties could not agree on the date of the deposition and the Court imposed a penalty on one of the lawyers who imposed a date unilaterally and in an inflexible manner. The Court ended the ruling with advise regarding the standards expected of Delaware lawyers, which includes: “Resisting importunate demands for aggressive litigation tactics, whether those demands originate externally with the client or internally from the belligerent emotions that inevitably cloud at times the judgment of those engaged in the adversary process.”
Francis G.X. Pileggi and Kevin F. Brady, over the last five months or so, have highlighted on this blog approximately 100 cases on corporate and commercial law from the Delaware Supreme Court and the Delaware Court of Chancery. Among those cases, we selected the following cases as the most notable during that period of time. The excerpts below from the case summaries also provide links for accessing a more complete synopsis of each case, as well as the full text of each highlighted decision.
Delaware Supreme Court Decisions
Lisa, S.A. v. Mayorga, No. 410, 2009 (Del. Supr. Apr. 20, 2010), read opinion here.
This Delaware Supreme Court decision affirmed the decision of the Court of Chancery which dismissed the complaint based on forum non conveniens grounds. The prior decision of the Court of Chancery is highlighted here.
Although this case has a lengthy and tortuous history, the sum and substance of the importance of this decision can be briefly summarized as follows:
1) When other pending actions in other jurisdictions are involved, the test to apply to a motion to dismiss on forum non conveniens grounds is the “overwhelming hardship” test. See generally General Foods Corp. v. Cryo-Maid, Inc., 198 A.2d 681, 684 (Del. 1964) ( as supplemented by Parvin v. Kaufmann, 236 A.2d 425, 427 (Del. 1967)) (Listing the six factors that the Court must consider in determining whether to apply the forum non conveniens doctrine).
2) Importantly, however, when a Delaware action is not the “first filed” action, a different standard will apply. The Supreme Court in this case ruled that: “where the Delaware action is not the first filed, the policy that favors strong deference to a Plaintiff’s initial choice of forum requires the Court freely to exercise its discretion in favor of staying or dismissing the Delaware action.” (the “McWane doctrine”) (emphasis in original). See McWane Cast Iron Pipe Corp. v. McDowell-Wellman Engineering Co., 263 A.2d 281, 283 (Del. 1970). As a general rule, litigation should be confined to the forum in which it is first commenced and a Defendant should not be permitted to defeat the Plaintiff’s choice of forum in a pending suit by commencing litigation involving the same cause of action in another jurisdiction of its own choosing.
Notably, at a recent seminar presented by veteran members of the Delaware Bar and a former member of the bench, the view was expressed that this case enunciates what is, in effect, a somewhat new standard–or at least it announces a distinction not previously well-known, and it also indicates a softening of the prior hard-line stance in these types of cases.
In this case, the Court reasoned that because the Delaware action was not the first filed action, the McWane doctrine applied and under that doctrine it is not necessary that the competing cases be exactly the same, but rather, it is sufficient that they be “functionally identical” to the Delaware action and that they were filed in a jurisdictionally competent Court arising out of a “common nucleus of operative facts. See Chadwick v. Metro Corp., 2004 WL 1874652 at *2 (Del. Aug. 12, 2004).
Also, the Court ruled that even if the prior action was no longer pending, and despite McWane referring to a prior pending action, this Delaware case should still be dismissed, the Court reasoned, because to allow the Delaware action to proceed after the dismissal with prejudice of the prior Florida action would ignore the binding effect of Florida adjudication and also create the possibility of inconsistent and conflicting rulings, which was precisely the outcome that the doctrine of comity espoused by McWane sought to prevent. Because the Court dismissed on forum non conveniens grounds, it did not reach the issue of whether the trial court should have allowed jurisdictional discovery on personal jurisdiction issues. See the complete summary at the following link:
Crown EMAK Partners, LLC v. Kurz, Consol. Nos. 64, 2010 and 85, 2010 (Del. Supr. April 21, 2010), read opinion here. This 55-page Delaware Supreme Court decision affirmed in part and reversed in part the Court of Chancery’s 80-page decision involving a control contest that featured issues such as “vote buying” and efforts to reduce the size of the board via a bylaw amendment and written consents of shareholders in lieu of a meeting. The trial court’s initial decision was summarized here, and the Chancery decision on an interim application for attorney’s fees issued shortly thereafter was highlighted here.
This important opinion deserves extensive discussion and commentary which time constraints do not allow today, but the bullet points below provide a glimpse of why practitioners and students of Delaware corporate law need to read the whole opinion. Additional analysis of this opinion should follow soon. In the meantime, the following key points indicate why it will be included in the pantheon of seminal Delaware rulings.
- Although Delaware’s High Court agreed with the Court of Chancery’s decision that there was no improper vote buying, the Supreme Court (unlike the trial court), determined that the purchase of voting rights and other enumerated rights was a breach of the applicable Restricted Stock Agreement, and therefore, those votes could not be counted. The Court’s treatment of this topic is must reading for those interested in the extent to which Delaware will permit a separation of voting rights from economic rights of stock.
- Both Courts reviewed the requirements for written consents of shareholders in lieu of a meeting pursuant to DGCL Section 228, and they both recognized the requirement that such consents be executed by a stockholder of record–and that DGCL Section 219(c) provides that only stockholders of record who appear on the stock ledger can vote. Where the two Courts diverged, however, was at the point that the Court of Chancery determined that “… if a Cede breakdown is part of the stock ledger for purposes of Section 220(b), it logically should be part of the stock ledger for purposes of Section 219(c)….” The Supreme Court determined that due to its finding that the purchased votes were invalidated, it was not necessary to address or decide the issue of whether the Cede breakdown is part of the stock ledger for Section 219 purposes. Thus, it described the trial court’s treatment of that issue as “obiter dictum.”
- The Supreme Court also agreed with the Court of Chancery that the bylaw amendment, that purported to reduce the size of the board as a means of eliminating sitting directors, was in violation of DGCL Section 109(b). Rather, the correct procedure would have been for the dissidents to follow a three-step process: First, remove the sitting directors by written consent, and then reduce the size of the board, and then elect new directors. See the complete summary at the following link:https://www.delawarelitigation.com/2010/04/articles/delaware-supreme-court-updates/delaware-supreme-court-addresses-vote-buying-and-effort-to-reduce-the-size-of-a-board-to-remove-sitting-directors/
Nemec v. Shrader, Del. Supr., Nos. 305, 2009 and 309, 2009 (Del. Supr. Apr. 6, 2010), read opinion here.
This Delaware Supreme Court opinion features an unusual and vigorous dissent, but is especially noteworthy for its statement of Delaware law on the implied duty of good faith and fair dealing which is imposed on every Delaware contract by both statute and case law. The decision of the Court of Chancery, which was highlighted on this blog here, was affirmed by the majority in this opinion.
Background and Issues
The abbreviated factual setting of this case involves a complaint by two retiring shareholders that the directors of their company exercised the right to redeem their shares shortly before a merger which would have made the value of all shares of the company worth $60 million more. The Chancery Court dismissed claims that the timing of the redemption and the failure to allow the retiring shareholders to participate in an increased value of $60 million was a breach of the implied covenant of good faith and fair dealing. The trial court also dismissed claims of unjust enrichment and a breach of the fiduciary duty by the directors who made the decision. A majority of the Delaware Supreme Court affirmed the dismissal of all of those counts.
Implied Duty of Good Faith and Fair Dealing
For the latest iteration of Delaware law on the implied duty of good faith and fair dealing, pages 10 through 16 of the slip opinion in this matter are required reading. This claim is rarely successful and the truisms that the Court recites to support its reasoning include the following: “We will only imply contract terms when the party asserting the implied covenant proves that the other party has acted arbitrarily or unreasonably, thereby frustrating the fruits of the bargain that the asserting party reasonably expected.” (Footnote 13) (emphasis added).
The majority emphasized that it is the intent of the parties at the time of contracting that must be examined. (emphasis in original.) Delaware’s High Court further reasoned that: “Delaware’s 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, that later adversely affected one party to a contract. Rather the covenant is a limited and extraordinary legal remedy.”
Moreover, the Court added that: “A party does not act in bad faith by relying on contract provisions for which that party bargained, where doing so simply limits advantages to another party. We cannot reform a contract because enforcement of the contract as written would raise “moral questions.” See footnotes 26 and 27.
Primacy of Contract Bars Fiduciary Duty Claims
The Court recited the well-settled principle in Delaware that “when a dispute arises from obligations that are expressly addressed by contract, that dispute will be treated as a breach of contract claim. In that specific context, any fiduciary claims arising out of the same facts that underlie the contract obligations would be foreclosed as superfluous.” See footnote 31. This “primacy of contract” principle applied here to bar fiduciary duty claims that arose from a dispute relating to the exercise of a contractual right – – which was the right of the company to redeem the shares of the retiring shareholders. See footnote 31. Moreover, the Court rejected the argument that because the directors benefited from the redemption of the shares that prohibited the participation of the retiring shareholders in the additional $60 million compensation from the merger, because the directors received the same proportionate benefit as all the other non-retiring stockholders. Thus, the Court reasoned that they were making a rational business judgment to exercise a contractual right of the company that benefited all of the current stockholders rather than favoring retired stockholders. See footnotes 22 and 23.
The Court recited the five elements for a cause of action for unjust enrichment, and determined that the plaintiffs failed to demonstrate each required element. Moreover, the Court emphasized that a claim for unjust enrichment will not prevail when the alleged wrong arises from a relationship governed by contract. See footnotes 34 through 37. See the complete summary at the following link:
Court of Chancery Cases
Chancery Rejects Request to Enjoin Freeze-Out by Controlling Stockholder
In Re CNX Gas Corp. Shareholders Litigation, C. A. Consol. No. 5377-VCL (Del Ch. May 25, 2010), read 43-page opinion here.
The Delaware Court of Chancery denied a request for a preliminary injunction in this expedited matter in which the representatives of a putative class of minority stockholders challenged a controlling stockholder freeze-out structured as a first-step tender offer to be followed by a second-step short-form merger.
Applicable Standard of Review
The Court applied the unified standard for reviewing controlling stockholder freeze-outs described in the case of In Re Cox Communications, Inc., Shareholders Litigation, 879 A.2d 604 (Del. Ch. 2005), but explained first as follows at page 14 of the slip opinion:
” As knowledgeable readers understand all too well, Delaware law applies a different standard of review depending on how a controlling stockholder freeze-out is structured.” (citing Kahn v. Lynch Communications Systems Inc., 638 A.2d 1110(Del. 1994)).
The entire fairness standard was applied to the facts of this case for several reasons: (i) the special committee did not recommend the transaction; (ii) the special committee was not provided with the authority to bargain with the controller on an arm’s length basis; and (iii) there was a reasonable question about the effectiveness of the majority-of-the-minority tender condition. The “flip side” of that is the reason the BJR did not apply .
That is, the BJR did not apply because there was no affirmative recommendation by the special committee AND there was no approval by the majority of unaffiliated stockholders.
Reason Why Preliminary Injunction Denied
The Court reasoned that in light of the fairness standard applying, any harm to the putative class could be remedied by a post-closing damages action. Moreover: (i) there was no viable disclosure claim; and (ii) the tender offer was not coercive.
Chancery Finds Purchase and Use of Corporate Jet to be Protected by the Business Judgment Rule, But Allows Claims to Proceed to Trial in Connection with Personal Benefits Received by Director of Family Owned-Company
Sutherland v. Sutherland, C.A. No. 2399-VCN (Del. Ch. May 3, 2010), read opinion here. This decision is the latest installment in a long-running internecine battle among siblings in a large, closely-held business based in the Pacific Northwest. The eight (8) prior decisions of the Delaware Court of Chancery in this matter have been highlighted on this blog and are available here.
The latest iteration of this family feud involves a motion for partial summary judgment which was granted in part and denied in part. There are many examples in Delaware opinions of lengthy battles among shareholders in large closely-held, family-owned companies that over the span of many years resulted in multiple decisions from the Court of Chancery in the same case. This case deserves a place “on the podium as one of the top three finalists” among such hotly contested disputes.
The first complaint that was filed in this matter was a Section 220 claim filed in 2004. The decision in that case is captioned Sutherland v. Dardanelle Timber Co., 2006 WL 1451531 (Del. Ch. May 16, 2006). The Court allowed documents to be inspected based on credible evidence of possible management entrenchment, as well as possible waste and other breaches of fiduciary duty.
In 2006, the same plaintiff filed a complaint against the same company (and its directors) based on breach of fiduciary duty claims. The company appointed a special litigation committee (“SLC”) which recommended that the company not pursue the derivative claims. However, the Court denied the motion to dismiss based on that SLC report, finding that the investigation by the SLC was lacking in good faith and reasonableness, and that the SLC failed to investigate adequately all of the claims. See Sutherland v. Sutherland, 958 A.2d 235, 242-45 (Del. Ch. 2008).
The primary claims addressed in the instant motion for summary judgment include the following: (1) The defendant directors breached their fiduciary duty of loyalty by allowing the company to pay for certain accounting expenses incurred for the benefit of one or more of the directors personally; (2) The purchase and continued use of a company jet was challenged based on the argument that the personal use was a breach of the duty of loyalty, and the decision regarding the jet was allegedly made on an uninformed basis such that it was a breach of the duty of care, and that the purchase and continuing ownership of the jet was not for a rational business purpose; (3) The third claim was based on the argument that the expenditure by the company of $750,000 in legal fees merely to defend the Section 220 action unsuccessfully, was a waste of corporate assets and was the result of self-dealing and bad faith; (4) The fourth argument was that an amendment to the charter after the litigation commenced to include a Section 102(b)(7) provision to protect the directors with self-dealing; (5) The last primary argument was that an accounting should be provided to establish that the company did not pay for personal expenses of the individual directors.
The first claim addressed by the Court is based on the premise that a director may be held liable for receiving some personal benefit that is not shared by other shareholders generally and that was the result of the director’s actions. See footnote 20. However, the Court rejected the argument that simply by appointing the Special Litigation Committee the directors conceded self-dealing. The appointment of an SLC pursuant to Zapata Corp. v. Maldonado, 430 A.2d 779, 786 (Del.1981), may allow for the inference at the initial pleadings stage that a claim for self-dealing was alleged, but it does not concede self-dealing as a substantive matter for purposes of trial or other merits-based decisions by the Court. See footnotes 21 to 26.
In sum, the Court concluded on this particular point that it was a factual issue for purposes of summary judgment, and that the Court could not conclude on the present record that the directors received no material benefit from tax and accounting services that they received personally. Moreover, the Court found that the absence of documentation to support the inference that at least one director received a disproportionate benefit for personal expenses that were paid for him is a problem for the defendants who could not account for the funds paid at this stage of the proceedings.
The second claim concerning the argument that a private jet was not necessary to purchase or to continue to own, was rejected for several reasons. First, it was barred by the statute of limitations, but more importantly, the claims failed to rebut the presumptions of the business judgment rule. The familiar formulation of the business judgment rule was reiterated by the Court. See footnote 71. Moreover, the Court observed that conduct may rebut the presumption upon the showing that the board breached either its fiduciary duty of care, or fiduciary duty of loyalty, but that the decision of the board will be upheld unless it cannot be attributed to any rational business purpose. See footnote 72 and 73.
The duty of due care of directors includes the need to act on an informed basis, although in order to be adequately informed “the board need not know every fact, but is instead responsible only for considering material facts that are reasonably available.” See footnote 76. Moreover, the standard for determining whether the decision of the board was informed is one of gross negligence which is conduct that “constitutes reckless indifference or actions that are without the bounds of reason.” See footnotes 78 and 79. Importantly, the Court emphasized that in connection with analyzing this duty, there is “no prescribed procedure, or a special method that must be followed to satisfy the duty of due care.” See footnotes 80 and 81. See generally DGCL Section 102(b)(7).
The Court also reasoned that the purchase of the aircraft and continued ownership of it clearly had a rational business purpose and was protected by the business judgment rule since it was not otherwise the product of self-dealing.
The argument was also made that because the company incurred approximately $750,000 in legal fees merely to defend the Section 220 action (unsuccessfully), that expense was allegedly an example of the breach of the duty of loyalty because it was merely for self interest that the Section 220 litigation was defended.
The Court observed that it is customary, especially in a closely-held corporation, for the corporation to pay the legal costs to oppose a Section 220 or a Section 225 claim even though there may be some personal benefit to incumbent management by doing so. See footnotes 103. The controlling question, rather, is whether the defendants acted in bad faith by refusing the request for books and records and by contesting the Section 220 action. The Court distinguished the Technicorp and Carlson cases in which the Court had found that there was a bad faith opposition of Section 220 actions that resulted in fee shifting, but those cases were distinguishable from the facts of the instant matter. See footnotes 103 through 106.
The Court also cited to prior Delaware decisions to reject the argument that adopting a Section 102(b)(7) provision (during the litigation) to protect the directors from personal liability was self-dealing. Those arguments had been rejected in prior decisions by the Court of Chancery.
The Court also discussed the Technicorp and Carlson cases in connection with the truism that fiduciaries have a burden to maintain and produce records to explain expenses paid for by the company, but an accounting is only required where improper expenses, or expenses that are unaccounted for, would warrant the Court to require an accounting.
Lastly, the Court acknowledged that because some of the more excessive provisions of the compensation package in the employment agreements of the top executives of the company were changed and made “less generous” as a result of the lawsuit, the Court ruled that some fee shifting would be allowed but that those details would be addressed in a separate proceeding. See the complete summary at the following link:
Binks v. DSL.net, Inc., C.A. No. 2823-VCN (Del. Ch. Apr. 29, 2010), read opinion here.
Main Issue Addressed
This 44-page opinion of the Court of Chancery addressed whether the business judgment rule protected the decision of the Board of DSL.net, Inc. on the following issue: Whether to file for bankruptcy or borrow funds from co-defendant MegaPath, Inc.?
The Board chose the deal with MegaPath which involved a loan from MegaPath and the issuance to MegaPath of convertible notes which were exercised to give MegaPath more than 90% of the common stock of DSL, after which it proceeded with a short-form merger and eliminated the minority stockholders. One of those minority stockholders brought this action.
After extensive anlaysis, the Court dismissed the claims for two primary reasons. First, the Plaintiff lost his standing to sue derivatively as a result of the merger. Second, he challenged the actions of the Board of Directors which was comprised of a majority of independent and disinterested directors who had reasonably evaluated the options of the company and solicited responsible advice.
The Business Judgment Rule and Revlon Duties
The Court recited the familiar presumption that directors of corporations enjoy when they act “independently, with due care, in good faith, and in the honest belief that their actions were in the stockholders’ best interests.” This business judgment rule presumption operates, as the Court explained, to “protect corporate officers and directors and the decisions they make, and our courts will not second-guess these business judgments.” See footnotes 37 to 40.
The Court further explained that Delaware courts apply the protections of the business judgment rule “to decisions made by disinterested and independent directors acting in good faith and with due care. Where business judgment rules are applicable, the board’s decisions will be upheld unless it cannot be attributed to any rational business purpose.” See footnotes 41 and 42.
However, where a transaction constitutes a “change in corporate control,” then Revlon duties “refocus the Board’s traditional fiduciary duties and require it to try in good faith to seek the best value reasonably available to the stockholders.” Where the duty under Revlon applies, the Court’s ordinarily deferential rational basis review is changed to an objective reasonableness standard of review, both to the process and the result, under which the Court evaluates whether the board has complied with its fundamental fiduciary duties. See footnotes 43 and 44.
It was not clear that Revlon applied to the particular transaction involved in this case although the Court recognized that even if it was a two step transaction, for analytical purposes the relevant events would be “collapsed” into a single transaction for purposes of determining the applicable standard of review. The Court has applied the Revlon standard to a transaction that has the net effect of a change in corporate control, especially where “corporate action plays a necessary part in the formation of a control block where one did not previously exist.” See Equity-Linked Investors, L.P. v. Adams, 705 A.2d 1040, 1055 (Del. Ch. 1997).
The Court in the instant case was more flexible because of a pro se Plaintiff and acknowledged that by applying the Revlon standard it would arguably allow for a direct claim. However, the Court concluded that even if the Revlon standard applied the obligations of Revlon were met for the following reasons:
1) The board was independent and disinterested regarding the challenged transaction;
2) The board was well-informed by independent advisors of the available alternatives to the company other than the loan from MegaPath; and
3) The board acted in good faith in arranging and committing the company to the challenged transaction, especially in light of the paucity of other options available.
The Court thoroughly examined the basis for its conclusion that the directors were both independent and disinterested, as well as being fully informed. That part of the opinion is factually rich.
The “entire fairness standard” did not apply because MegaPath was not a controlling shareholder at the time of the contested transaction, and that standard would only apply to an actual–not a potential–majority shareholder. See footnote 78.
Decision of the Board Not to File Bankruptcy
The Court relied heavily on the Equity-Linked Investors’ case in its analysis about why the Revlon standard was upheld in connection with the decision of the board to obtain loans as opposed to filing for bankruptcy. The Court rejected the argument from the Plaintiff that bankruptcy was the only other option that would have been preferable because:
“There can be several reasoned ways to try to maximize value. [Thus] the Court cannot find fault so long as the directors chose a reasoned course of action.” See footnote 66. Moreover, the conclusion of the board that the financing transaction was preferable to bankruptcy was within the exercise of its business judgment, and the argument of the Plaintiff to the contrary does not meet the test that the board “utterly failed” to obtain the best price for the shareholders.
In the Equity-Linked Investors case, the preferred shareholders questioned the judgment of the board on the “lip of insolvency” when the board was required to complete a financing transaction rapidly, or else face bankruptcy. The preferred shareholders preferred to have the company liquidated and the assets distributed but the board declined an offer that was perhaps superior to the offer of a third party. Nonetheless, the Court in that case concluded that a board’s obligation to maximize the present value of the firm’s equity was “not obvious” where: (1) The transaction is not a merger or a tender offer with a price for shares; and (2) the transaction or other alternatives were not otherwise easily reduced to a present value calculation. See footnote 69.
Therefore, the Court reasoned that: “The board could have reasonably concluded that pursuing a course that maintained the possibility of further benefits from the company’s assets, including its intellectual property, was arguably superior to the liquidation of the firm.”
The Court acknowledged the difficulty of applying the Revlon test in such circumstances where judgment is required, but reasoned that :
“All that the law may sensibly ask of corporate directors is that they exercise independence, good faith and attentive judgment, both with respect to the quantum of information necessary or appropriate in the circumstances and with respect to the substantive decision to be made.” See footnote 70.
The Court relied on the holding in the Equity-Linked Investors case in which the board was found to have acted reacted reasonably in pursuit of the “highest achievable present value” of the common stock in concluding in good faith that the “corporation’s interests were best served by a transaction that it thought would maximize potential long-run wealth creation.”
Likewise in the instant case, the Court reasoned that the Plaintiff had failed to plead adequate grounds to infer that the board was anything other than independent, disinterested, and sufficiently well informed ,and therefore his personal opinion that the bankruptcy would have been a superior course of action, cannot sustain a Revlon claim.
The Court also observed the well settled standard for liability of a director for breach of the duty of care as being based on the concept of “gross negligence.” See footnote 56. However, because any duty of care violation would be exculpated by Section 102(b)(7) of DSL’s charter, the Plaintiff was unable to prevail in that aspect of his claim either. See the complete summary at the following link:
OneScreen, Inc. v. Hudgens, C.A. No. 4545-VCP (Del. Ch. March 30, 2010), read opinion here.
This Delaware Court of Chancery opinion will be useful to include in the toolbox of litigators who need to know about the latest iteration of Delaware law on the issue of personal jurisdiction, especially as it relates to in rem jurisdictional arguments based on stock ownership in a Delaware corporation.
The issue addressed in this opinion by the Court of Chancery was whether personal jurisdiction in Delaware can be based solely on the fact that a defendant owns stock in a Delaware corporation. The short answer is that it is theoretically possible but only as a narrow exception to the general rule which the plaintiff in this case failed to satisfy.
This case involved the effort by OneScreen, Inc. to rescind the transfer of preferred stock from a former CEO based on an argument that it was in violation of Florida criminal statutes and therefore should be voided as against public policy even though OneScreen was not a party to the related stock agreements.
Plaintiff argued that it was not seeking jurisdiction over any person but rather was asking the Court to exercise jurisdiction over property–or in rem jurisdiction based on Section 169 of the Delaware General Corporation Law, and Section 365 of Title 10 of the Delaware Code. That argument was unsuccessful.
The defendant successfully moved to dismiss for lack of jurisdiction based on the seminal ruling of the United States Supreme Court in Shaffer v. Heitner and its progeny, standing generally for the position that: “Ownership of stock in a Delaware corporation, on its own, is an insufficient basis on which to hale nonresident defendants into a Delaware Court.” See footnotes 1 and 9. The Court also refers to Court of Chancery Rule 19 for the observation that personal jurisdiction over the parties to the agreement sought to be invalidated would be indispensable, and the inability to obtain personal jurisdiction over them, as opposed to merely in rem jurisdiction, would not allow the Court to proceed in any event.
Due Process Concerns
The narrow exception that would allow the Court to proceed when the only connection to Delaware is ownership of stock in a Delaware corporation would be in those limited circumstances where minimum contacts could be satisfied conceivably in a situation where an action related directly to the “rights or attributes inherent in that stock.” See footnotes 20 through 35 for cases cited.
The Court discussed a series of Delaware cases that interpret the decision of the United States Supreme Court in Shaffer to mean that “ownership of stock that has its statutory situs in Delaware does not, by itself, satisfy the minimum contacts requirement. See footnote 30. Rather, ownership of stock in a Delaware corporation may be a sufficient contact with Delaware to subject the owner of stock to jurisdiction in this Court, “but only in actions relating directly to the legal existence of the stock or its character or attributes.” See footnote 39.
Conclusion and Reasoning
The Court’s conclusion and reasoning can be summarized in the following three parts: First, this action must be dismissed because it does not relate directly to the legal existence, rights, characteristics, or attributes of stock in the Delaware corporation. Second, the complaint does not allege a defect in the corporate process by which the disputed shares were issued nor does it ask the Court to examine those shares in terms of the internal governance of a Delaware corporation. Lastly, the action challenges transactions that only incidentally involve stock in a Delaware corporation. In closing, the Court distinguished this case from corporate plaintiffs in the Hart Holding opinionof this Court in which cancellation of shares was sought as an equitable remedy for fraud. By contrast, OneScreen seeks in this case to invalidate a stock transfer in response to an alleged violation of a Florida criminal statute that does not implicate the corporate process or the validity or attributes of the corporation’s stock. Thus, there is a failure to allege sufficient minimum contacts to support the exercise by the Court of jurisdiction over the defendants. See the complete summary at the following link:
Julian v. Julian, C.A. No. 1892-VCP (Del. Ch. March 22, 2010), read opinion here. This is the latest in a series of decisions by the Court of Chancery in this case that involves litigation over the break-up of several affiliated family businesses. Prior Chancery opinions in this long-running internecine imbroglio have been highlighted here, here,here and here.
Three issues addressed by the Court of Chancery in this opinion should be of particular interest to readers of this blog because they are likely to be of wide-ranging applicability for those dealing with valuations of closely held businesses based on a stockholders’ agreement in connection with a business break-up.
First, in the context of a valuation provision in a stockholders’ agreement, the Court was called on to determine if it had the power to alter or set-aside an appraisal done pursuant to that agreement but that one of the parties argued was flawed.
Second, the Court decided whether the reference to real estate holdings in the agreement, required a valuation to be done of interests that the company had in other LLCs which owned real estate (as opposed to the company owning the real estate directly).
Third, the Court explained the principle known as “course of performance” as a method to interpret an otherwise ambiguous contract. The Court decided many other issues in this ruling that are likely to be of the sui generis variety and so will not be covered in this overview.
Contract Interpretation Principles.
After reciting the well-known principles of Delaware’s objective theory of contracts, whose goal is to determine the intent of the parties as expressed in the clear language of the document, the Court next addressed what to do when the language of the parties’ agreement is not so clear. If there are two reasonable interpretations of the agreement, it is deemed ambiguous and the Court may then consider factors outside the four corners of the document. In determining the intent of the parties in light of ambiguous language, the Court may consider the following objective evidence:
“the overt statements and acts of the parties [e.g., the drafting history of a document], the business context, the parties’ prior dealings and industry custom.” (See fn. 37)(brackets are mine).
In this search, the Court cited to the Restatement (Second) of Contracts for the principle that: “…courts should consider the parties’ course of performance as the ‘most persuasive evidence of the [meaning of] the parties agreement’” See fn. 38 (brackets in original). Footnote 38 also cites to a case that is quoted for the following statement of Delaware law: “Course of performance …may also be used to supply an omitted term when a contract is silent on an issue.”
In connection with the foregoing, the Court of Chancery examined correspondence among the parties to the agreement that preceded the amendment of the agreement at issue in this case. The Court also examined communications among the parties after the amendment to the agreement was signed to review how the parties referred to and understood the provisions in the agreement at issue in this case.
The Court quoted from Black’s Law Dictionary and a standard English dictionary in its analysis of the word “hold” in order to determine if the phrase “real estate held by the company” should include options to buy real estate (no), and interests in other entities that owned real estate (yes).
Review of Appraisal Report based on Valuation Formula in Stockholders’ Agreement
The parties wanted the Court to invalidate certain appraisal reports performed ostensibly pursuant to valuation formulae in the parties’ stockholders’ agreement. The Court refused to examine the minutiae of the myriad aspects of the disputed appraisals, but instead reviewed them in the same deferential manner that it would review the decision of an arbitrator in light of the similarity between the decision of an appraiser and the decision of an arbitrator empowered by the provisions of an agreement among parties to a dispute. Of course, the Court’s work on this issue was made easier by the consent of the parties to this review standard due to the absence of any procedure in the agreement that addressed the circumstances under which a party could challenge an appraisal submitted by another. See footnotes 81 and 82.
Specifically, the parties agreed that the Court should only set aside an appraisal in this context where there is evidence that the appraisal is the product of fraud, bad faith, partiality or deception.
Despite arguments that the appraiser did not consider all relevant factors and did not comply with the applicable MAI standards, the Court did not find that the allegations rose to the level of fraud, bad faith, partiality or deception, and thus refused to set aside or modify the appraisals at issue.
Although footnote 82 refers to cases that recognize the notion that Courts have greater authority to review contractually-provided appraisals than arbitration awards, footnote 83 discusses the comparably high threshold under the Delaware Uniform Arbitration Act at Sections 5714 and 5715 of Title 10 of the Delaware Code, that must be met before a Court may either vacate or modify an arbitral award.(e.g., when the arbitrator exceeded her authority or the arbitrator ruled on an issue outside the scope of matters submitted to her.)
Sub-Issue: What if a second appraisal obtained by the parties is for an amount less than the challenged one? Answer: It can be discarded if not formally submitted.
An ancillary issue arose in the context of a provision in the agreement that allowed a party who disagreed with the MAI appraiser of one party, to obtain a second MAI appraisal and the two would be averaged. However, in this case, the party who obtained a second MAI appraisal apparently later realized that his MAI appraisal turned out to be lower than the original MAI appraisal obtained by the adverse party he was challenging.
Thus, the issue presented was whether he was “stuck” with the second appraisal he obtained (which would have been averaged with the first one and lowered the amount payable to him), or if he could “take it back” and decide not to use the second one he obtained.
The Court reasoned, based on the wording of the agreement that did not require the second “challenger” appraisal to be “averaged with the first appraisal” unless it was formally submitted to the opposing party for that purpose, and because the “the party that initially wanted to challenge the first appraisal” did not “formally submit the second appraisal”, it was not required to be used to “average out” the first appraisal. Apparently, the reason he obtained a second appraisal, is because he regarded the first appraisal as confusing and did not realize that the first appraisal resulted in a higher valuation than he had thought.
Sub-Issue: May a settlement offer still be accepted after new Counteroffer is made? No
The Court discussed whether a settlement offer could still be accepted after a counteroffer was made. Footnote 94 cites to cases that stand for the basic contract law that, generally speaking, a counteroffer is a rejection of the offer and “terminates the power of acceptance” if it is not identical to the terms of the offer.
Although other ancillary issues are addressed by the Court, the foregoing are the only ones that are likely to be of widespread interest or application by readers of this blog or those engaged in business litigation for a living (or “students” of corporate law generally).
Chancery Allows Claim to Proceed for Nullification of Certificate of Cancellation Due to Failure of Dissolving Entity to Provide Adequate Reserves for Known Liabilities; Court Rejects Argument that Likely Bankruptcy Makes Nullification Futile
Thor Merritt Square, LLC v. Bayview Malls, LLC, C.A. No. 4480-VCP (Del. Ch. March 5, 2010), read opinion here.
In this decision, the Court of Chancery allowed a claim to proceed for nullification of a Certificate of Cancellation of the Certificate of Formation of the entity involved, due to pending unresolved liabilities and a failure to provide for adequate reserves for those known liabilities.
This case arises out of the alleged failure of one party to a purchase and sale agreement for a shopping center, to perform or pay for work required under that agreement. Two of the defendants were sellers of the shopping center. The agreement required separate entities referred to as “Bayview Malls” and “Holdings” to perform certain work to bring stores into compliance with the applicable fire code. However, despite Bayview Malls and Holdings never performing the work and refusing to pay for the work when it eventually was performed by the plaintiffs, both Bayview Malls and Holdings terminated their existence without ever paying for, or making reasonable provision for payment of, the required work.
Plaintiffs sued parties described as “defendants John Doe 1-22, as managers and members of Bayview Malls and Holdings.” Although the Court did not decide the issue, the plaintiff withdrew its claim against John Doe defendants in connection with an argument no such procedure was permissible in Delaware.
On a procedural level, the Court denied the Motion to Dismiss or in the alternative for Stay of the claim for nullification of a Certificate of Cancellation.
Defendants’ position on the request for nullification was based on three grounds: (1) The provision for unmatured contract claims was made by putting funds in escrow and that was sufficient for Section 18-804(b) of Title 6 of the Delaware Code; (2) Reviving the dissolved entities would be futile because they had no assets and would file for bankruptcy; and (3) The nullification claim should be barred by the analogous statute of limitations.
The Court reviewed the familiar standard under Rule 12(b)(6) for a Motion to Dismiss and then recited the requirements under Section 18-804(b) of the Delaware LLC Act which mandate that a reasonable provision be made for unmatured contractual claims. Specifically, that section provides in relevant part as follows: “A limited liability company which has dissolved: (1) Shall pay or make reasonable provision to pay all claims and obligations, including all contingent, conditional or unmatured contractual claims, known to the limited liability company.”
The Delaware LLC Act requires a dissolving LLC to make reasonable provision for the payment of unmatured contractual claims before filing its Certificate of Cancellation. See footnote 17 which also notes that Section 18-804(b)(3) requires a dissolving LLC to make provision not only for known liabilities but also for liabilities that “have not arisen but that, based on facts known to the limited liability company, are likely to arise or to become known to the limited liability company within ten years after the date of the dissolution.”
Based on the liberal Motion to Dismiss review standard, the Court was required to accept as true the allegations in the complaint that would support an inference that the defendants failed to make reasonable provision for unmatured claims. Moreover, assertions to the contrary were merely evidence of the existence of genuine issues of material fact as to reasonable provisions being made and those issues of fact could not be determined on a Motion to Dismiss.
The Court rejected the argument that a dissolved entity could not be sued after its Certificate of Cancellation became effective. The Court cited to prior decisions which held that Section 18-803(b) does not require dismissal of a complaint that seeks nullification on the ground that an LLC failed to wind-up in compliance with the LLC Act. See footnote 18 (citing Metro Communications Corp. BVI v. Advanced MobileComm Techs. Inc., 854 A.2d 121, 138-39 (Del. Ch. Apr. 30, 2004)).
In addition, the Court rejected the arguments of defendants on procedural grounds because the arguments were not included in their opening brief. See Ct. Ch. R. 7(b) and 171. See also footnotes 20 to 22.
In addition, the Court rejected the argument that the likelihood of filing for bankruptcy if the nullification claim prevailed would make the effort futile, because the nullification of the cancellation would still facilitate, for example, the ability of the plaintiffs to pursue their related efforts to pierce the corporate veil of the dissolved entities.
In sum, the Court allowed to proceed the claim to nullify the cancellation of the Certificate of Formation of the entities that failed to make adequate reserves for claims against them.
In London v. Tyrrell et al., C.A. No. 3321-CC (March 11, 2010), read opinion here, the Court of Chancery denied a special litigation committee’s (“SLC”) motion to dismiss a shareholder’s lawsuit under Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981), because there were material questions of fact regarding: (1) the SLC’s independence, (2) the good faith of its investigation, and (3) the reasonableness of the grounds upon which the SLC recommended dismissal of the lawsuit. A prior Chancery ruling in this case was highlighted on this blog here.
Kevin Brady, a highly regarded Delaware litigator, prepared this synopsis.
In 1996, plaintiffs Craig London and James Hunt and defendants Patrick Neven and Walter Hupalo, and others founded iGov, a government contracting firm. In 2005, after changing its focus, iGov won a 5-year $300 million contract with the United States Special Operations Command (the “TACLAN” contract). Because of the expenses it incurred in reinventing itself, iGov’s CEO, Neven, hired Michael Tyrrell as a consultant (he later replaced London as CFO of iGov) to help iGov find a lender to supply it with an operating line of credit. Textron Financial surfaced as a possible candidate. Around the same time, defendants decided that it would be advisable to implement an equity incentive plan (the “2007 Plan”) for the benefit of key members of management. Chessiecap Securities, Inc. was retained to value iGov stock for purposes of setting the exercise price of options for the 2007 Plan.
The Valuation Rollercoaster
Throughout 2006, Tyrrell distributed a number of 2007 forecasts which reflected ever-changing EBITDA. On May 4, 2006, Tyrrell sent Textron a fiscal year 2007 forecast reflecting an EBITDA of approximately $3.5 million (the “First Textron Forecast”). On August 15, 2006, Tyrrell sent Textron an updated 2007 forecast showing an EBITDA of roughly $3 million (the “Second Textron Forecast”). On August 23, 2006 Tyrrell sent Chessiecap a 2007 forecast that showed an EBITDA which also had a value of approximately $3 million (the “Original Chessiecap Forecast”). On October 2, 2006, Chessiecap valued iGov equity at $5.5 million, however, Tyrrell told Chessiecap that in his view $5.5 million was “probably on the high side.” On October 18, 2006, Tyrrell sent Chessiecap a revised forecast that eliminated certain revenues and expenses and showed an EBITDA of $1.8 million (the “Revised Chessiecap Forecast”). On October 31, 2006, Chessiecap certified its Final Valuation of the equity of iGov at $4.7 million. Finally, on December 8, 2006, Tyrrell sent Textron another updated 2007 forecast that showed an EBITDA of approximately $3.1 million (the “Third Textron Forecast”).
London and Hunt are Removed as Directors
In January, a split in the board developed over the correct valuation to use. On January 7, 2007, Tyrrell sent an email to iGov management regarding a proposal to purchase London’s shares for $4 per share, but he wanted an updated valuation since he felt that iGov’s “valuation will likely be higher than $4.7 million [the Final Valuation]. . . .” On January 16, 2007, London objected to iGov relying on Chessiecap’s Final Valuation for purposes of the 2007 Plan because he felt the information upon which the Final Valuation was based was stale and inaccurate. On January 17, 2007, Hunt, who also believed the Final Valuation was unreliable, made an offer to buy all of Neven’s stock at $28 per share. Defendants Neven and Hupalo, who owned 42.5% of iGov’s voting stock, teamed up with iGov officer and shareholder Jack Pooley (collectively they owned 50.1% of iGov’s voting stock), and executed written stockholder consents removing London and Hunt from the board and electing Tyrrell to the board.
The 2007 Plan is Adopted
Defendants then engaged Chessiecap to prepare an addendum to its Final Valuation in which, among other things, Chessiecap concluded for the first time that the fair market value per share as of July 31, 2006 was $4.92. Defendants then held a special meeting of the iGov board on January 30, 2007 to consider the 2007 Plan under which the defendants were given 60% of the options granted and the plaintiffs were given no options or shares. The 2007 Plan also provided that the exercise price of the options could not be less than 100% of the fair market value of iGov common stock on the date the options were granted. Defendants unanimously voted as directors to approve the 2007 Plan and simultaneously adopted $4.92 per share as the fair market value of iGov shares on January 30, 2007 based on Chessiecap’s Final Valuation, dated July 31, 2006, and the associated addendum.
Former Directors File Suit
After the 2007 Plan was approved, plaintiffs filed a books and records action under 8 Del. C. § 220. Plaintiffs engaged the McLean Group, a valuation firm, to conduct separate valuations of iGov’s equity as of October 31, 2006 and December 31, 2006 (the “McLean Valuations”). In performing the McLean Valuations, McLean used the Second Textron Forecast rather than the Revised Chessiecap Forecast. The McLean Valuations placed the per share value of iGov equity at $13.32 on October 31, 2006 and $15.45 on December 31, 2006. Around this same time, iGov expanded the size of its board from three members to five, adding Vincent Salvatori and John Vinter. On October 31, 2007, after attempts to resolve the dispute failed, plaintiffs filed their complaint. In February 2008, the complaint was amended in response to defendants’ motion to dismiss. The plaintiffs claimed that the defendants breached their fiduciary duties of care and loyalty in that the defendants materially misrepresented iGov’s business prospects to Chessiecap in order to get a lower valuation for them to acquire iGov stock. The plaintiffs sought, among other things, rescission of the options granted to defendants under the 2007 Plan.
On November 21, 2008, the iGov board formed a two-member SLC comprised of the two new board members (Salvatori and Vinter) to consider whether it was in iGov’s best interest to pursue the derivative claims in plaintiffs’ complaint. The SLC hired legal and financial advisors and conducted an investigation from April 2009 to July 2009. During the investigation, the SLC’s financial advisor (“SRR”) performed valuations of iGov as of October 31, 2006 and January 30, 2007 without reviewing the work done by Chessiecap and McLean. The SLC concluded that October 31, 2006 was an appropriate valuation date because it believed that Chessiecap’s Final Valuation was essentially current as of October 31, 2006, despite being dated July 31, 2006. The SLC determined that January 30, 2007 was an appropriate date because it was the date the challenged 2007 Plan was adopted. SRR also concluded that since iGov was worth $3.90 – $4.15 per share as of October 31, 2006 and $5.24 – $5.39 per share as of January 30, 2007, the $4.92 per share price was “within the range of fair market value” based on the SRR valuations.
SLC Recommends That the Lawsuit Be Dismissed
On August 5, 2009, the SLC filed a Report concluding that the suit was not in the best interests of the Company and recommending that it be dismissed. The SLC concluded that the defendants acted properly in adopting the 2007 Plan and did not breach their duties of care or loyalty. With regards to the duty of care, the SLC found that the 8 Del. C. § 102(b)(7) provision in iGov’s certificate of incorporation exculpates directors from personal liability not involving intentional misconduct or knowing violations of the law. The SLC concluded that a duty of care claim should not be pursued because any breach of care conduct, if it occurred, would be covered by the § 102(b)(7) provision. As to the duty of loyalty, the SLC concluded that defendants’ approval of the 2007 Plan and actions leading to that approval would satisfy the entire fairness standard because the process employed was fair and the $4.92 price was fair. The SLC also determined that no rescission of the options granted under the 2007 Plan was necessary because $4.92 was in the range of fair market value.
Two-Step Analysis under Zapata
Under the Delaware Supreme Court’s decision in Zapata Corp. v. Maldonado, 430 A.2d 779 (Del. 1981) there is a two-step analysis that must be applied to the SLC’s motion to dismiss. First, the Court must review the independence of SLC members and whether the SLC conducted a good faith investigation of reasonable scope that yielded reasonable bases supporting its conclusions. In the second step, the Court applies its own business judgment to the facts to determine whether the corporation’s best interests would be served by dismissing the suit.
Independence Questioned – “Caesar’s Wife” or “My Cousin Vinter”
The Court noted that an SLC member is not independent if he or she is incapable, for any substantial reason, of making a decision with only the best interests of the corporation in mind. Quoting the Supreme Court’s decision of Beam v. Stewart, 845 A. 2d 1040, 1055 (Del. 2004):
Unlike the demand-excusal context, where the board is presumed to be independent, the SLC has the burden of establishing its own independence by a yardstick that must be “like Caesar’s wife”-“above reproach.” Moreover, unlike the presuit demand context, the SLC analysis contemplates not only a shift in the burden of persuasion but also the availability of discovery into various issues, including independence.
In this instance, it was undisputed that neither Salvatori nor Vinter had a personal stake in the challenged transactions and neither faced any risk of personal liability in this action. However, the Court was troubled by the fact that Vinter was related to Tyrell (Vinter’s wife was Tyrell’s cousin) and Salvatori used to work for Tyrell.
While the Court admitted that it was not possible, at this stage of the proceedings, to say unequivocally that either Vinter’s or Salvatori’s independence was impaired, the burden was on them to show no material question existed about their independence.
The Court determined that they had failed to meet that burden. Moreover, the Court noted that there was evidence to suggest that Vinter and Salvatori may not have conducted their investigation objectively after having considered plaintiffs’ claims. In concluding that the SLC failed to satisfy the independence prong of Zapata, the Court stated that members of an SLC “should be selected with the utmost care to ensure that they can, in both fact and appearance, carry out the extraordinary responsibility placed on them to determine the merits of the suit and the best interests of the corporation, acting as proxy for a disabled board.”
“Scope” of Investigation and “Bases” for Conclusion Questioned
To conduct a good faith investigation of reasonable scope, the Court stated that the SLC had to investigate all theories of recovery asserted in the plaintiffs’ complaint and explore all relevant facts and sources of information that bear on the central allegations in the complaint. If the SLC failed to do that, the result would raise a material question about the reasonableness and good faith of the SLC’s investigation.
Here the SLC concluded that § 102(b)(7) provisions such as iGov’s are routinely upheld by Delaware courts and that such a provision protects defendants from personal liability, in the form of money damages, for gross negligence. However, the Court rejected the SLC’s conclusion stating “I find this to be an unreasonable conclusion because the SLC failed to consider that the requested relief in plaintiffs’ complaint is not limited to money damages; it specifically requests that the 2007 Plan be rescinded. Under Delaware law, exculpatory provisions do not bar duty of care claims ‘in remedial contexts . . ., such as in injunction or rescission cases.’
The SLC also concluded that plaintiffs’ duty of loyalty claims should be dismissed because it believed that the 2007 Plan was entirely fair to iGov — (1) the process defendants’ employed to secure approval of the 2007 Plan, particularly the process employed to develop the exercise price, was entirely fair, and (2) $4.92 was a fair exercise price. The Court disagreed finding that it was not acceptable for Tyrell to provide Chessiecap with the Revised Chessiecap Forecast showing an EBITDA of $1.8 million while simultaneously providing Textron with multiple iterations of EBITDA forecasts. The Court stated that this type of behavior in the current economic environment was particularly troubling:
As is evident from the SLC Report, the SLC concluded that the process of adopting the 2007 Plan was fair primarily because the SLC believes it was perfectly normal for Tyrrell to provide “optimistic” and “art of the possible” forecasts to Textron and use those forecasts internally, while at the same time providing a forecast to its valuation expert that was “substantially lower” but something the Company could “actually achieve,” rather than being “wishful.” To put it mildly, this is an interesting conclusion, especially in light of the current credit environment. One would suspect that lenders would prefer a forecast projecting what management believes is actually achievable as opposed to wishful.
The Court also identified a number of questions which were not adequately investigated by the SLC, including: (i) why did Tyrrell provide Chessiecap with the Original Chessiecap Forecast (showing an EBITDA of roughly $3 million) if he did not believe that the projections in that forecast were actually achievable? and (ii) why did Tyrrell provide Textron with the Third Textron Forecast (showing an EBITDA of 3.1 million) after he provided Chessiecap with the Revised Chessiecap Forecast (showing an EBITDA of $1.8 million)?
As to “Fair Price,” the Court questioned how the SLC could determine that both the Chessiecap Final Valuation and McLean Valuations were “tainted” and as a result, the SLC did not rely on either valuation (or any other valuation) in concluding that $4.92 was a fair price. Since the SLC had no professional valuation upon which to rely, the Court found that a material question of fact existed about whether the SLC had a reasonable basis to conclude that $4.92 was a fair price. Finally, with respect to the second prong of Zapata, since the Court found that the SLC failed the first prong of Zapata, the Court noted that it was unnecessary to continue the analysis because the result would not change.
SUPPLEMENT: Professor Bainbridge refers here to a review of the case by Theodore Mirvis and then the good professor suggests that the Delaware standard applicable in this case could benefit from some tweaking to address the unwieldy nature of the formulation of the standard.
In Re Revlon, Inc. Shareholders Litigation, Consol. C.A. No. 4578-VCL (Del. Ch. March 16, 2010), read opinion here. This is a Court of Chancery opinion that is certain to generate copious commentary. The Court removed the original Co-Lead Counsel and appointed new Co-Lead Counsel for the class.
A cursory review makes it clear that this opinion is destined to be cited often for several reasons. For example, it describes the practice and some history of firms who file class actions in the Court of Chancery very soon after a public announcement of a transaction and the ensuing battle for lead counsel among firms filing competing complaints involving the same contested transaction. Footnotes refer to law review articles and prior Chancery decisions that chronicle the issues that arise in this context, often involving the same firms that the Court refers to as “frequent filers” in this Court. The Court also refers to this phenomenon as the “opening steps in the Cox Communications Kabuki dance.” (Slip op. at 8.)
The opinion includes scholarly analysis regarding the criteria employed by the Court in its selection of lead counsel in class actions, noting that the size of plaintiff’s holding is not always determinative. Without any intent to “name names” and having no interest in identifying firms on this blog that suffered in this case, it must be noted that the Court concluded that original counsel did not “provide adequate representation.”
The Court cites to many academic sources that discuss the policy issues that arise in these types of cases, as well as the “pros and cons” of what the Court refers to as “entrepreneurial litigators” who have a portfolio of class action cases. There is much more to commend this decision as must-reading for any lawyer or plaintiff who files a representative action in the Delaware Court of Chancery. A fuller synopsis will follow soon.
Although this remarkable opinion is only 44-pages in the “slip opinion format,” it speaks volumes about the practical and theoretical aspects of representative litigation, as well as the standards that the Court enforces on all counsel that appear before it.
Much of the opinion discusses the types of class actions that arise in the context of what the Court referred to as the Cox Communications ritual, referring to the case of In re Cox Communications, Inc., 879 A.2d 604, 608 (Del. Ch. 2005). That “ritual” as to the Court describes it, involves a common practice in many representative suits that are hastily filed very shortly after the announcement of a controlling shareholder transaction. The Court has referred to these hastily prepared and hastily filed complaints as part of the “medal round of filing speed Olympics to seek lead counsel status.” See footnote 2. In footnotes 1 and 4, the Court cites to a law review article that refers to an academic analysis that concluded: “Firms who are early filers are frequently early settlers,” (leading some wags to label them “Pilgrims.”) In addition to referring to it as a ritual, the Court also refers to the situation in this case as “part of a Cox Communications Kabuki dance which involves two tracks.” The first track involves representative counsel doing “not very much” in the litigation, while the controlling shareholder and the special committee for the company move forward along the transactional track.
That procedure followed form in this case with a twist. The financial advisor for the Special Committee indicated that it would not be able to render a fairness opinion for the transaction and the Special Committee therefore could not recommend the proposed transaction. However, the controlling shareholder in the company did a “end run” around the Special Committee by proposing a slightly new transaction to the whole entire board and not the Special Committee. Thus, the Special Committee declared that its work was complete and disbanded.
Although the board declined to make any recommendation to stockholders on whether or not to tender their shares, the board did authorize Revlon to proceed with the proposed transaction.
The Litigation Track Restarts and the Parties Enter into a Memorandum of Understanding
The Cox Communications ritual was described by the Court as follows: Once the corporation and the controlling shareholder reached an unofficial agreement on the terms of the transaction, the plaintiffs were brought in to “bless the deal.” The transaction provided for consideration for a settlement and the payment of attorneys’ fees and a broad transaction-wide release for all defendants. The minor tweaks in the transaction followed in what the Court called this “traditional choreography.” The transactional tweak traditionally involves lowering the termination fee which would only become operative in the event of a topping bid and supplemental disclosures which provide convenient ways to settle litigation over a deal that has already been exposed to the market for some time, by which point it is relatively clear to the parties that an interloper is unlikely to appear.
Importantly, one of the tweaks made in this case by the parties was already required by Delaware case law in order to render a controlling stockholder tender offer as non-coercive. The court suggested that the provision would have been included anyway as a requirement under Delaware law that a controlling stockholder tender offer be conditioned upon tenders from a majority of the outstanding unaffiliated shares. The Cox Communications case is known for requiring that if a tender offer by a controlling shareholder is to be considered no-coercive, when enough shares are tendered such that the remaining holders can be eliminated for a short-form merger, then the squeezed-out stockholders would receive securities and the surviving corporation substantially identical to the shares it would have received.
The court regarded the changes to the ultimate terms of the deal as being the result of very little if any influence by the plaintiff’s counsel and the Memorandum of Understanding (MOU) exaggerates the role of counsel in obtaining settlement. The Court refers throughout the opinion to “Old Counsel” as the counsel that it replaced.
New Actions Filed
After the MOU was entered into, new representative actions were filed that challenged the transaction. Unlike the original actions filed by Old Counsel, Fox challenged a negotiable proposal, the new actions challenged in actual transaction. New counsel argued that there was a conflict between the positions of the tendering stockholders that they represented and the non-tendering stockholders represented by the Old Counsel.
The Court quoted extensively from terms of the Amended Complaint filed by plaintiffs’ Old Counsel with a purpose to protect “defendant’s turf and the settlement” which was inconsistent with the record before it.
The Court was also critical of defense counsel who supported the settlement and also made statements to defend the settlement that the Court regarded as “not quite accurate” (my phrase).
The Court cites to a treatise and to several federal decisions to support its statement that the Court has both the power and the duty to either select or remove class counsel. Although there may not be substantial case law in the Court of Chancery on this topic, comparatively speaking, the Court cited to several cases which list the factors that are important in choosing lead counsel, such as the quality of the pleading, the willingness and ability to litigate vigorously on behalf of an entire class, and the enthusiasm or vigor with which the various contestants have prosecuted the lawsuit. See Hirt v. U.S. Timberlands Serv. Co., 2002 WL 1558342 at *2 (Del. Ch. July 3, 2002) and Wiehl v. Eon Labs, 2005 WL 696764, at *1 (Del. Ch. May 22, 2005). Notably, the Court emphasized that the size of plaintiff’s share ownership is not a determinative factor in selecting lead counsel.
Transaction was not a Voluntary, Non-coercive Tender Offer that Avoided Entire Fairness Review
The Court made it clear that this was not a transaction that avoided entire fairness review based on the case of In Re Siliconix, Inc. Shareholders Litigation, 2001 WL 71677 (Del. Ch. June 19, 2001). The Siliconix case rests in part on the non-involvement of the target board from the Delaware corporate law perspective. Rather, as a series of cases noted, corporate action by the target board takes a transaction out of the Siliconix framework. See, A.G. Andra v. Blount, 772 A.2d 183, 195 n. 30 (Del. Ch. 2000).
The Court also noted other reasons why the entire fairness standard would apply to the deal in this case in part because none of the following safe harbor provisions applied: (1) There was no affirmative recommendation from an independent committee of the target board; (2) It was not subject to a non-waivable condition that a majority of outstanding unaffiliated shares tender; and (3) There was no commitment by the controller to effect a prompt back-end merger. Moreover, in this case the outside directors believed that they could not obtain a fairness opinion for the deal. The Court observed that if there was ever a case that warranted the entire fairness review standard, this may be one of those cases.
The Court recognized the important role of representative cases as a check on management, and that many cases achieve meaningful results. The Court recognized also the sound policy reasons for the Court to police representative counsel.
At footnote 6, the Court cited to multiple law review articles, and addressed the pros and cons of representative cases and what the Court refers to as “entrepreneurial litigators” who specialize in handling these types of cases. This opinion made it clear that the Court will act as a very “strict policeman,” and the Court recognizes that one possible consequence of that approach would be that “frequent filers” may accelerate their efforts to populate their portfolio of cases by filing in other jurisdictions. The Court recognized also that while “in the short run policing frequent filers may cost some members of the bar financially, in the long run it enhances the legitimacy of our State and its law not to facilitate a system of transactional insurance through quasi-litigation.”
The Court requires New Counsel to Perform Confirmatory Discovery
In addition to appointing new lead counsel, the Court specifically at pages 43 and 44 outlined in detail minimum discovery that new counsel had to conduct through both traditional written discovery methods and through depositions in this case. The itemized description on pages 43 and 44 of the slip opinion is in some ways unique to this case, but it provided a road map for confirmatory discovery that will be a useful reference in some respects for representative counsel seeking to have the Court approve class action settlements in the future.
UPDATE: I want to draw readers’ attention to two transcripts of subsequent hearings in separate, unrelated cases by the same author of this opinion, here and here, where the Court “softened the impact” of the references in this opinion to some of the firms involved in this case in a manner that would tend to prevent use of the opinion against those firms in the future. The ruling in this case, and the above-linked transcripts, are indications of the special emphasis that the Court places on the role of Delaware lawyers in a case populated with many “out of town counsel.” See the complete summary at the following link:
Dweck v. Nasser, C.A. No. 1353-VCL (Del. Ch. March 10, 2010), read letter decision here.
Prior decisions of the Court of Chancery involving this matter have been highlighted on this blog here.
This short three-page letter decision refused to apply the Statute of Frauds to an oral agreement that was terminable by either party at any time “upon performance of an act which is within the control of one of the parties.” The Court reasoned that because the “performance of the agreement could be completed within one year without breach by either party”, the Statute of Frauds did not bar its enforcement.
In a previous decision in this matter, the Court of Chancery ruled that the oral agreement still being disputed in the instant ruling, (which is based in part on an unsigned draft shareholders’ agreement), could not serve the purpose of a “voting agreement” due to the requirement of DGCL Section 218(a) that voting agreements or voting trusts be in writing. Nonetheless, the Court observed, nothing prevents the application of another state’s contract law, such as New York in this case, to issues such as contract formation at the same time that the DGCL governs the validity of the corporate governance implications of the contract. (The Court also notes parenthetically its preference on how to deal with a motion to amend pleadings.) See the complete summary at the following link:
PT China LLC v. PT Korea LLC, No. 4456-VCN (Del. Ch., Feb. 26, 2010), read letter decision here. Many thanks to Peter Ladig, one of the Delaware counsel of record in this case, for forwarding this decision to me the same day it was issued. (The photo below is of the Kent County Courthouse, where the Court of Chancery hears cases in Dover, although a new Courthouse is under construction.) This 29-page decision should be included in the tool box of every Delaware litigator who needs to know about obtaining jurisdiction over a “manager” of a Delaware LLC who may not have any other contacts with Delaware.
Threshold Issue: Whether personal jurisdiction can be imposed on a Singapore resident based on Section 18-109 of the Delaware LLC Act, and if so, if the exercise of such jurisdiction comports with due process prerequisites?
Consent Statute for LLC Managers
Analogous to the consent statute for directors of corporations at 10 Del. C. Section 3114, managers of Delaware LLCs are deemed to consent to the personal jurisdiction of Delaware courts pursuant to Section 18-109 when they agree to serve as a manager of an LLC, and when the suit is “involving or related to the business of the limited liability company or a violation by the manager…of a duty to the limited liability company, or any member….” Even so, due process must still be satisfied.
“Manager” is defined broadly in Section 18-101(10) to include a person who “participates materially in the management of the limited liability company.” Obviously this covers a rather broad class of people, including one who may not be formally bestowed with the appellation of manager as that term is often used in a colloquial sense.
Is Due Process Satisfied if Section 18-109 Imposes Jurisdiction for Claims “Relating to Business and Affairs of the LLC” as compared to Fiduciary Duty Claims Against a Manager?
Delaware Courts have previously determined that if claims against a manager of an LLC relate to his or her fiduciary duty obligations, then due process considerations are satisfied when Section 18-109 is used to imposed jurisdiction. See footnote 22 and cases cited. The more nuanced issue in this case is whether the same conclusion can be reached when the claims are not necessarily based on fiduciary duty violations. Prior cases suggest a consideration of three factors to address this issue: (i) do the allegations focus on the rights, duties and obligations of the manager; (ii) is the matter “inextricably bound up in Delaware law”; and (iii) Delaware has a strong interest in providing a forum for disputes relations to actions of managers of a limited liability company formed under its law in discharging their managerial functions.
Sub-Issue: Do Contractual Claims Bar Fiduciary Duty Claims Based on the Same Conduct due to the “Primacy of Contract Law in Delaware” over Fiduciary Claims Involving Matters Based in Contract Rights and Duties.
Prior decisions of this Court have recognized that “a contractual claim will preclude a fiduciary duty claim, so long as ‘the duty sought to be enforced arises from the parties’ contractual relationship'”, due to the primacy of contract law. See fns. 32 to 34 for cases cited. The appropriate question to ask in order to analyze this issue is “whether there exists an independent basis for the fiduciary duty claims apart from the contractual claims, even if both are related to the same or similar conduct.” See fn. 34.
The Court explained that it was not necessary to find that the claims against the manager were based on fiduciary duties in order to apply Section 18-109 to impose jurisdiction. Rather, so long as the action “involves the manager’s rights, duties, and obligations to the company”, due process will be satisfied under the consent statute. See fn. 35. There was no issue in this case about whether the operative agreement limited fiduciary obligations and related liability. Compare generally, Kelly v. Blum decision by Chancery highlighted earlier this week here.
The Court reasoned that the instant dispute is “intertwined with the defendant’s [manager’s] managerial position”, and coupled with “… the potential usefulness of his involvement in this suit, and Delaware’s interest in adjudicating disputes involving the management of its limited liability companies…”, the Court found justification for exercising jurisdiction in this matter consistent with “constitutional standards of fairness and substantial justice.” See fns. 43-44. See generally, In Re USACafes, L.P. Litigation, 600 A.2d 43, 52-53 (Del. Ch. 1991). The Court noted parenthetically, however, that it was not passing judgment on whether the contract-based claims would prevail at a later stage of the proceedings in terms of being plead sufficiently. See the complete summary at the following link:
Kelly v. Blum, No. 4516-VCP (Del. Ch., Feb. 24, 2010), read opinion here. This 49-page opinion of the Delaware Court of Chancery deserves more extensive treatment–that I hope to provide soon, but for the time being, I will highlight a few bullet points regarding issues of law addressed by the Court that warrant closer reading for most lawyers who make their living in the fields of business litigation.
- Confirmation of prior Delaware decisions that in the absence of an LLC Agreement provision to the contrary, both members and managers of an LLC owe traditional fiduciary duties of loyalty and care to each other and the entity. See footnote 69.
- The Court found “substantial compliance” with a notice provision in the agreement to be sufficient. See pages 22 and 23.
- The two exceptions to the requirement of being a member or shareholder before pursuing a derivative action.
- Analysis of whether a claim is direct or derivative.
- Elements of a defamation claim.
UPDATE: Professory Larry Ribstein provides an insightful analysis of the case here (which may obviate the need for me to provide a fuller synopsis myself this weekend.) His commentary is especially helpful on the issue of the prerequisites to waiving fiduciary duties. The good professor also discusses in a separate post here, in connection with this case and a recent NY case, whether the Delaware courts would allow, by agreement, the law of another state to apply to a Delaware LLC, contrary to the Internal Affairs Doctrine. See the complete summary at the following link:
Dawson, et al. v. Pittco Capital Partners, L.P., et al., No. 3148-CC (Del. Ch.,Feb. 15, 2010), read letter decision here. Kevin Brady, a highly regarded Delaware litigator, provided this synopsis.
In a short discovery-related letter opinion, Chancellor Chandler granted plaintiffs’ motion to compel full interrogatory responses from defendants related to, among other things, the factual and legal bases (including each element) of each defense of the defendants’ four affirmative defenses: failure to state a claim, laches, waiver, and unclean hands. Additionally, one of the defendants had apparently resisted production of documents that were in the possession of its wholly-owned subsidiary, which was not a party to this litigation. Apparently finding no Court of Chancery decision on point, Chancellor Chandler cited Delaware federal case law interpreting Federal Rule of Civil Procedure 34 noting that “Federal Court decisions are ‘of great persuasive weight in the construction of parallel Delaware rules’ due to the analogous nature of the Court of Chancery Rules and the Federal Rules of Civil Procedure.” The Chancellor rejected the defendant’s position and required it to produce the requested documents from the wholly-owned subsidiary. See the complete summary at the following link:
Whittington v. Dragon Group L.L.C., No. 2291-VCP (Feb. 15, 2010), read opinion here.
Previous decisions of the Delaware courts in the long line of cases involving this internecine warfare among family members fighting over their interests in various business entities, have been summarized on this blog and can be found here.
This latest iteration by the Delaware courts in this matter comes to us after remand by the Delaware Supreme Court involving an important High Court ruling that the applicable statute of limitations for claims on a contract “under seal” is 20-years. See summary of Delaware Supreme Court decision here.
In addition to defining laches and applying its elements such as “unreasonable delay,” the Court of Chancery in this decision concluded that laches would not bar a claim that was brought a little after 3-years from the date that “inquiry notice” was imputed, in light of the statute of limitations that was 20-years long.
Also helpful for litigators is the definition by the Court of Chancery of “inquiry notice” at page 11 of the slip opinion.
Also of practical use for future reference is the definition by the Court of Chancery of the doctrine called “law of the case” and how that compares and differs from the obligation of the trial court after remand by the Supreme Court to apply new rulings of law. See Slip Op. at 8 to 10. See the complete summary at the following link:
Why This Short Ruling is Noteworthy
This decision in noteworthy because it applies a statute that, comparatively speaking, does not enjoy a copious body of case law interpreting it. The statute in question is the dissolution statute for LPs, Section 17-802 of Title 6 of the Delaware Code. Decisions interpreting this dissolution statute have also been applied by analogy to the counterpart statute in the Delaware LLC Act, Section 18-802. These statutes allow for one to petition to dissolve an LP or an LLC when: “it is not reasonably practicable to carry on the business in conformity with the partnership [or LLC] agreement.”
This case involved two parties who owned an LP, called RHH Partners, that in turn owned the personal residence of the sole limited partner who owned 99% of the LP. The remaining 1% was owned by a former friend who was also the general partner. Harris, the 99% owner and general partner, was a New York lawyer by training and appeared in this case pro se, as did the general partner.
Despite a general purpose clause authorizing the LP to operate “for all lawful purposes”, the Court found after hearing testimony that the purpose of the LP “was not entirely clear” though it likely evolved over time. The Court concluded that: “its purpose, however ill-defined, ceased to exist”, and therefore, based on Section 17-802, the court held that “it is not reasonably practicable for RHH to carry on the business in conformity with the partnership agreement.”
Moreover, the Court reasoned that: (i) leaving the two partners “in any kind of business relationship would serve no useful purpose”; and (ii) there is no apparent purpose for the LP; and (iii) using the LP as a vehicle to own Harris’ residence “has no cognizable relationship to any business purpose for which RHH might exist.”
Ordering dissolution did not end the discussion. For the winding-up aspect of the case, the Court divided ownership of the sole asset of the LP, the personal residence of Harris, in the same proportion as the two men owned the LP. Thus, Harris received a “99 % fee simple interest ” in the real estate, and the other partner received a “1% undivided fee simple interest”. The Court noted that before distribution of the assets could be made, Section 17-804 required that creditors be paid.
Notwithstanding the unusual procedural aspect of both parties appearing pro se, thus resulting in a less developed factual record and fewer formal legal arguments presented, the issue the Court addressed is sufficiently important, and the case law on the dissolution statute sufficiently meager–by comparison to many corporate statutes for example, that this ruling merited a quick overview. See the complete summary at the following link:
This 43-page Delaware Court of Chancery decision could serve as a “mini-law review article” that explains the current Delaware law on a wide range of issues important to those involved in corporate derivative litigation, and directors who want to understand the standards by which their conduct will be reviewed by the courts.
The factual and procedural background of this matter is that it is a class and derivative action challenging a stockholder rights offering (“Offering”). The shareholder plaintiff alleges that the directors of the company set the Offering at a deliberately and inadequately low price that would trigger anti-dilution provisions in the agreements governing the stock options and warrants of the controlling shareholder. The shareholder plaintiffs argued that the triggering of the anti-dilution provisions resulted in a benefit being enjoyed by the directors that was not shared by the other shareholders and therefore, was a self-dealing transaction. The Court found, however, that the complaint failed to state a claim because the anti-dilution provisions did not change or challenge the pre-existing contractual rights of the directors which left them in substantially the same position they were in before the rights Offering. Thus, the shareholder did not sufficiently allege disloyal conduct by, for example, showing that the directors acquiesced to the wishes of the controlling shareholder.
This cursory review will simply highlight key aspects of the Court’s opinion so that the interested reader can decide to review the full text of the decision on their own at the above link.
Court’s Summary of Issues in Case and Its Four-Part Holding
The Court described this case as one that “ultimately boils down to an alleged breach of the duty of loyalty and whether or not the defendants obtained a personal benefit through the Offering.” The Court’s reasoning and analysis can be summarized in four parts: (1) The Court cannot draw a reasonable inference from the facts that the Offering’s trigger of the anti-dilution provisions and their effect upon the options worked a material personal gain to the directors at the expense of the public stockholders. Nor did the plaintiff plead sufficient facts to support a claim that the directors acted in bad faith by consciously disregarding their fiduciary duties. (2) Because the court cannot reasonably infer from the facts that the directors received a personal gain by way of the collateral consequences of the Offering or consciously disregarded their duties, their decision to consummate the Offering is protected by the business judgment rule. (3) Of equal importance, the plaintiff has not duly alleged that the controlling shareholder dominated the board as it approved the Offering. (4) The derivative claims were barred because the plaintiff failed to plead that the board of directors were either interested or under the control or domination of an interested party as of the time it asserted the derivative claims.
Court Declines to Convert Motion to Dismiss into Motion for Summary Judgment
Robotti requested that the Court treat the motion to dismiss by the defendants as one for summary judgment because the defendants relied upon documents that were neither integral to, nor incorporated within, the complaint. The Court declined the invitation to treat the motion as one under Rule 56 as opposed to Rule 12(b)(6), which would have given the parties a reasonable opportunity to present all material relevant to a summary judgment motion. The Court observed that matters beyond the complaint may generally not be considered in a ruling on a motion to dismiss except in the following instances: “(1) When such documents are integral to, and incorporated within, the plaintiff’s complaint; or (2) When the documents are not being relied upon for the truth of their contents.” See footnote 49.
Direct v. Derivative Claims
The opinion contains a thorough discussion and analysis of the differences between a direct as compared to a derivative claim. Referring to recent Delaware Supreme Court opinions on the topic, the Court explained that an initial inquiry in determining between a direct and derivative claim requires the following two questions to be addressed: “(1) Who suffered the alleged harm – – the corporation or the shareholders individually; and (2) Who would receive the benefit of the recovery or other remedy?” See footnotes 55 and 56.
The Court discussed the recent cases that have analyzed whether a dilution in the value of corporate stock and overpayment by fiduciaries is direct or derivative. The recent decision in Gentile v. Rossette, 906 A.2d 91 (Del. 2006) was described as involving a controlling shareholder who caused the company to issue the controlling shareholder’s stock in return for debt forgiveness. The Supreme Court in Gentile held that both the corporation and the shareholders were harmed by the overpayment and due to the dual nature of the harm, the claims in that class were both derivative and direct.
Analysis of Bad Faith and Breach of Duty of Loyalty Claims
The Court described a methodology for analyzing allegations of bad faith within the context of a duty of loyalty claim as being recently clarified by the Delaware Supreme Court in Lyondell Chemical Co. v. Ryan, 970 A.2d 235 (Del. 2009). The Court of Chancery explained as follows:
“Mere gross negligence, which includes the failure to inform oneself of available material facts, cannot constitute bad faith. Bad faith, and thus a breach of the duty of loyalty, can arise only when a fiduciary consciously disregards his or her responsibilities. The Court in Lyondell imposed a high standard on any plaintiff advancing such a claim, and recognized a “vast difference between an inadequate or flawed effort to carry our fiduciary duties and a conscious disregard of those duties.” It concluded that fiduciaries in this context breached their duty of loyalty only if they “knowingly and completely fail to undertake their responsibilities.”
In this case, the Court found that Robotti never claimed that the defendants “knowingly and completely” failed to undertake their responsibilities, nor may any such inference be drawn from the complaint.
Business Judgment Rule Applies
This opinion provides a robust discussion of the business judgment rule, its applicability, and the pleading requirements under Rule 23.1.
Notably, this is the first Delaware decision that cites to the current version of the highly regarded four volume treatise on the business judgment rule recently published by Stephen A Radin and which is cited at footnote 89 by the Court as follows: 1 Stephen A. Radin, et al., The Business Judgment Rule: Fiduciary Duties for Corporate Directors 110 (6th ed. 2009).
Referring to the Radin treatise, the Court defines the business judgment rule as follows:
“The business judgment rule, as a general matter, protects directors from liability for their decisions so long as there exists a ‘business decision, disinterestedness and independence, due care, good faith and no abuse of discretion and a challenged decision does not constitute fraud, illegality, ultra vires conduct or waste.’ There is a presumption that directors have acted in accordance with each of these elements, and this presumption cannot be overcome unless the complaint pleads specific facts demonstrating otherwise. Put another way, under the business judgment rule, the Court will not invalidate a board’s decision or question its reasonableness, so long as its decision can be attributed to a rational business purpose.” See footnote 91.
The Court found that Robotti had been unable to allege that defendants were interested in the transaction and it also failed to allege bad faith or conscious disregard of fiduciary duty. Moreover, although Robotti may have plead a failure to act with due care and on an informed basis regarding the transaction, such a conclusion would be unhelpful in light of the provision in the charter pursuant to Section 102(b)(7) which would preclude a claim for damages on that ground.
The Court also conducted an analysis under Rule 23.1 and found that the derivative claims did not satisfy that rule. Footnote 95 and 96 made it clear that the applicable time period to determine whether the pre-suit demand requirement was futile was when the first derivative claim was presented–which was in the second amended complaint. The composition of the Board at that time when the first derivative claim was filed made the Rales v. Blasband case applicable. See 634 A.2d 927, 933-34 (Del. 1993). Under Rales, the Court explained that the relevant inquiry is only whether the board can exercise its independent and disinterested judgment in responding to a demand, where, as here, the majority of the directors responsible for that decision have since been replaced.
Definitions to Determine “Interested” or “Independent” Directors
The Court provides a helpful discussion and definition of the term “interested” for purposes of pre-suit demand upon the board. Likewise for pre-suit demand purposes, the Court provides a useful definition to determine whether a director is “independent” for purposes of a pre-suit demand analysis. See footnote 98: “The mere fact that a director receives some benefit that was not shared generally by all shareholders is insufficient; the benefit must be material.”
For purposes of demand excusal analysis, rather, the plaintiff must show that the alleged benefit was “significant enough in the context of the director’s economic circumstances, as to have made it improbable that the director could perform her fiduciary duties to the . . . shareholders without being influenced by her overriding personal interest.” See footnote 99.
Regarding the independence of a director, the Court emphasized the contextual aspect of the inquiry, which requires a Court to ask “whether the directors are so ‘beholden’ to an interested director or interested controlling shareholder, that ‘their discretion would be sterilized.’ Motivations such as friendship may influence the inquiry, but in order for friendship alone to neutralize the independence of a director, the ‘relationship must be of a bias-producing nature.’” See footnote 101.
The Delaware Supreme Court has required that a complaint identify a relationship between a disinterested director and the interested director or controlling shareholder “that is so close that one could infer that the ‘non-interested director would be more willing to risk his or her reputation than risk the relationship with the interested director.’” See footnote 103.
The Court analyzed the factual situation as it related to each board member at the time the derivative claim was made in the second amended complaint, and found that the complaint did not adequately justify excusal of a pre-suit demand.
Thus, because the Court found that a majority of the board at the time of the derivative claim was both independent and disinterested, Robotti did not sufficiently plead demand futility and to that extent his derivative claims were dismissed. In addition, the claim for self-dealing by interested fiduciaries failed as a matter of law and the facts did not support an inference that the directors consciously disregarded their fiduciary duties or entirely abdicated their responsibilities. Therefore, the complaint was dismissed. See the complete summary at the following link:
Xu Hong Bin v. Heckmann Corp., No. 4802-CC (Del. Ch., January 8, 2010), read letter decision here. The Delaware Court of Chancery previously granted partial summary judgment in favor of Xu on one of the counterclaims by Heckmann. Read summary of that prior decision in this case here. This ten-page letter decision from the Delaware Court of Chancery contains important analysis and recitation of Delaware law on both advancement and indemnification.
One of the key issues addressed by the Court was whether the provisions in the bylaws that allow the board to impose reasonable conditions prior to advancing legal fees were consistent with or contrary to the right to advancement contained in the Certificate of Incorporation.
The Court determined that there was no violation of Delaware General Corporation Law Section 109(b) in connection with the provisions in the bylaws that allowed the board to impose reasonable conditions on advancement, for two reasons. First, because the Court determined that the bylaw provisions were drafted and made effective contemporaneous with the provisions in the charter regarding advancement rights. Second, both documents were in effect when Xu began his service as a director and he should have been aware of the advancement provisions when he began his service as a director.
The Court observed that there was no requirement in Delaware law that all of the terms regarding advancement rights to which a person is entitled must be in one document. To the contrary, no such authority was presented to the Court.
Moreover, in light of Xu previously prevailing on Count III of Heckmann’s counterclaims, the Court granted summary judgment in his favor for indemnification with respect to Count III.
However, the Court denied a request for “fees on fees” in the instant advancement proceedings because Xu did not prevail on his pending claim for advancement to the extent that the Court upheld the arguments of Heckmann on the issue of conditions precedent to advancing fees, contrary to the position argued by Xu–the net effect of which was to allow Heckmann to impose reasonable conditions prior to granting advancement rights.
The Court observed as a procedural matter that fee advancement actions are especially appropriate for summary judgment proceedings because the entitlement of a party to advancement can be determined by applying the allegations contained in the pleadings to relevant corporate documents. Likewise, indemnification is also appropriate at the summary judgment stage where there are no material factual disputes germane to indemnification. See the complete summary at the following link:
MCG Capital Corp. v. Maginn, C.A. No. 4521-CC (Del. Ch. May 5, 2010), read opinion here.
The Court of Chancery addresses in this 73-page opinion an issue of first impression: Do preferred shareholders have the same right to bring a derivative claim as common shareholders? Short answer: yes (as a general proposition)
Review of Court’s Reasoning
The Court of Chancery ruled that “all stock is created equal.” See footnote 25. Specifically, the Court reasoned that preferred shareholders have standing to bring derivative claims absent some express limitation in the charter or in a preferred share designation or other controlling document. Preferred shareholders still must satisfy the continuous ownership requirement of DGCL Section 327 and the pleading requirements of Rule 23.1.
In addition to deciding directly for the first time that preferred shareholders have the same right to bring derivative claims as common shareholders, the Court also addressed the following important topics of Delaware corporate law in this opinion:
• The Court distinguished between direct and derivative claims and acknowledged that in some instances the same facts can give birth to both direct and derivative claims.
• For an officer or a director to be personally liable for intentional interference with a contract, the plaintiff must show that the intentional acts exceeded the scope of the authority of the officer or director. Moreover, mere wrongful interpretation of a contract is not the same as exceeding authority even when it causes the company to breach the contract.
• The parameters were described of those circumstances where duties owed to preferred shareholders sometimes rise to a fiduciary level, and when they are otherwise limited to a contractual nature. See footnote 84.
• The familiar disjunctive two-prong Aronson test is discussed for purposes of explaining when pre-suit demand is excused as futile. See notes 90 to 97 and accompanying text.
• The important definitional standards of “independence” and “disinterestedness” of directors were examined. Specifically, the issue of whether the loss of $100,000 in annual director compensation was material to the individual director was discussed but the Court determined that it need not be conclusively established at this stage. However, particulars did need to be alleged in the complaint from which the Court could infer that the objective judgment of the directors involved would be impaired by the threat of losing their director compensation, based on the individual director’s personal financial situation. Seefootnotes 125 and 127.
• Also examined was the standard used to determine if a derivative plaintiff is an inadequate or unqualified representative. See footnotes 132 to 134.
• Footnotes 148 and 149 and related text explain that “an accounting” is more of a type of relief or a remedy as opposed to a cause of action or a claim, but importantly the Court noted that if the allegations are well plead, the count for an accounting would not be dismissed on the basis of the form in which it appears in the complaint. Rather, the Court determined that it would sua spontemake it a part of the requested relief (instead of a separate count).
• The Court was patient but not pleased with the lack of clarity in the complaint in terms of the failure in the complaint to clearly distinguish between those counts that were direct and those claims in the complaint that were to be regarded as derivative.See footnote 14. Naturally the distinction is important for such things as determining compliance with Rule 23.1 in the case of derivative claims, or the applicability of Rule 8(a) for non-derivative claims in the context of a Motion to Dismiss. The Court cited at footnote 15 to Shakespeare’s Macbeth regarding the confusion in the complaint due to the lack of clarity between the identity of direct and derivative claims.
This is a short compilation of several sources that are useful references for new protocols that are either recommended or required for remote court proceedings, including remote depositions. The links below include reminders of professionalism standards and other norms that still apply in the context of these new technological developments.
The Delaware Court of Chancery recently issued an epic decision that serves as a mini-treatise on several topics of importance to corporate and commercial litigators including: (1) interpretation of material adverse change clauses or material adverse effect clauses in merger agreements; and (2) the meaning and application of the phrase “commercially reasonable efforts” or “reasonable best efforts” often found in merger agreements.
The opinion in Akorn, Inc. v. Fresenius Kabi AG, C.A. No. 2018-0300-JTL (Del. Ch. Oct. 1, 2018), will be firmly ensconced in the pantheon of the most notable decisions of Delaware courts and could easily be the subject of a full-length law review article. But for purposes of a blog post that merely attempts to highlight the key issues addressed by the court, so that interested readers might review the entire opinion if relevant to their practice, I will focus on several key aspects of the decision only.
The procedural context in which this decision was written, was expedited proceedings in which two parties to a merger agreement sought competing rulings on the meaning of the agreement. On the one hand, the seller argued that the merger agreement should be specifically enforced. The buyer, however, filed a counterclaim that sought a ruling that it properly terminated the merger agreement based in part on the occurrence of a material adverse effect or a material adverse change, as defined in the agreement. The purchaser prevailed in its argument that it properly terminated the agreement.
Notably, a 5-day trial was held with nearly 2,000 exhibits. A total of 16 witnesses testified, and 54 depositions were lodged. The trial was held less than 3 months after the complaint was filed. This 246-page opinion was issued less than one week after the final post-trial briefs and oral argument were completed.
The detailed facts on which the court’s reasoning and conclusion are based are described in the first 110 pages of this decision. It would be a challenge to do the facts justice in a brief overview, but for purposes of providing the highlights of the legal principles in the case, suffice it to say that the court provided exhaustive detail about each of the factual aspects of the parties’ dispute and why one party sought to enforce the merger agreement and one party successfully argued that it was justified in terminating the merger agreement prior to closing.
Highlights of Legal Principles and Analysis by the Court:
Material Adverse Change Clauses:
- In a comprehensive and scholarly analysis, the court surveys the law on Material Adverse Change (“MAC”) provisions or Material Adverse Effect (“MAE”) provisions in merger agreements, including prior cases that discuss them and copious footnotes are provided with reference to specific percentages, for example, that are necessary in determining whether a MAC clause or a MAE clause should be triggered. See pages 117 to 204. The court refers to a MAC clause and a MAE clause as synonymous.
- This decision is thought to be the first Delaware opinion upholding the termination of a merger agreement due to the occurrence of a MAC/MAE.
Key Treatise Cited:
- Notable is the court’s reference in footnote 558 to the many Delaware decisions that cite to the Kling and Nugent treatise on M&A agreements and M&A practice as an authoritative source for issues relating to merger agreements, such as MAC/MAE clauses and post-closing indemnification provisions.
Is Delaware Pro-Sandbagging—or Not?
- Importantly, the court discusses whether Delaware should be considered a “pro-sandbagging” state as it relates to the enforcement of representations in contracts when one party might know prior to closing that the adverse party’s representations are not accurate. See footnote 756 to 767 and accompanying text. But cf. Eagle Force Holdings LLC v. Campbell, in which the Delaware Supreme Court declined to affirmatively decide the issue, but questioned whether Delaware was a pro-sandbagging state. 187 A.3d 1209, 1236, n. 185 (Del. 2018); id. at 1247 (Strine, C. J. & Vaughn, J., concurring in part, dissenting in part). This case was previously highlighted on these pages.
- Also noteworthy is a robust explanation, with citations to many authorities, that describe the factors that must be considered to determine when the breach of a contract is material. See pages 208 to 211.
Commercially Reasonable Efforts and Reasonable Best Efforts:
- In what may be the most comprehensive analysis in a Delaware decision of the meaning of the phrase “commercially reasonable efforts” and similar phrases such as “reasonable best efforts,” the court discussed the meaning of these contractual standards and their variations, as well as how they should be interpreted and applied. See pages 212 to 220.
- The court compares the differences, if any, between these similar standards, with citations to treatises, cases and articles that discuss them. See pages 213 and 214, as well as footnotes 788 to 800.
- See generally Professor Bainbridge’s analysis of this topic with citations to many authorities. (The corporate law scholarship of Professor Stephen Bainbridge is often cited by Delaware courts.) See also several Delaware decisions highlighted on these pages that also discuss the topic.
- In its analysis of this topic, the Court of Chancery cites to the Delaware Supreme Court opinion in Williams Companies v. Energy Transfer Equity, L.P., highlighted on these pages. The Delaware high court explained in that decision that it: “did not distinguish between” the two phrases, “commercially reasonable efforts,” and “reasonable best efforts,” but rather the court described those phrases as both imposing “obligations to take all reasonable steps to solve problems and consummate the transaction.” (quoting Williams, 159 A.3d at 272). See also footnote 808, and accompanying text.
The Delaware Court of Chancery in Pipal Tech Ventures Private Limited v. MoEngage, Inc., C.A. No. 10381-VCG (Del. Ch. Dec. 17, 2015), applies the overwhelming hardship standard to deny a motion to dismiss based on a forum non conveniens argument even when the location of most of the events, witnesses and applicable law support the litigation taking place in a forum in India.
The key facts of the case involved an alleged theft of intellectual property by persons resident in India and subject to employment contracts governed by Indian law. Those employment agreements require disputes regarding those contracts to be litigated exclusively in the courts of the country of India. Nonetheless, the defendant corporation, which allegedly “possessed” the purloined intellectual property, was a Delaware corporation. The individuals resident in India who allegedly stole the software at issue were not subject to Delaware jurisdiction but pursuant to both the Hague Convention and Indian law, were subject to compulsory process so that their depositions could be compelled.
The court applied the six factors recited in the Delaware Supreme Court case of General Foods Corp. v. Cryo-Maid, Inc. Those factors include the relative ease of access to proof. Although in light of modern technology this factor is not as meaningful, this factor still supported the defendant’s motion to dismiss in light of virtually all the documentary and deposition evidence being in India. The fact that compulsory process is available in India favored the plaintiff, however.
The overwhelming hardship factor is a high threshold but not an impossible standard to meet. Notably, the mere fact that the law of a foreign country needs to be applied and relevant documents need to be translated and foreign law experts need to be retained at trial, does not, per se, satisfy the overwhelming hardship standard especially where, as in this case, the law of that foreign country on the issue at hand is well settled. The recent Delaware Supreme Court case in Martinez, by contrast, held that where there is a novel issue of another sovereign, that issue might be best determined by the courts of that sovereign country.
One final takeaway from this case that supported the reasoning of the court in denying the motion to dismiss was the public policy that Delaware has a powerful interest in preventing Delaware entities from being used a vehicles for fraud. The legitimacy of Delaware as a chartering jurisdiction depends on it. The allegations that the persons alleged to have stolen the trade secrets involved in this case, allegedly used a Delaware entity to do so, supported the selection by the plaintiff of Delaware as a forum in which to litigate the matter. See footnote 95.
In re Jefferies Group, Inc. Shareholders Litigation, Cons. C.A. No. 8059-CB (Del. Ch. June 5, 2015). This Delaware Court of Chancery letter ruling describes the standards that apply to a request for attorneys’ fees in connection with the settlement of a class action. This action arose out of a stock-for-stock merger of Jefferies Group, Inc. and the Leucadia National Corporation in 2013. The core of the suit was an alleged conflict of interest affecting four of the eight members of the board of Jefferies that, if proven, could result in the application of the entire fairness standard.
Highlights of Case
Delaware counsel sought attorneys’ fees in the amount of $27.5 million plus expenses in an amount exceeding $1 million. The requested fee equates to approximately 27.5% of the “gross value of settlement” (approximately $100 million) after taking into account the requested fees and expenses incurred by Delaware counsel, and an assumed amount of administrative expenses to be paid by defendants. The “gross value amount” was calculated approximately as follows: $70 million distributed to the class, $27.5 million fee award, $1 million in out-of-pocket expenses for which reimbursement was sought, and an estimated $1.5 million in administrative expenses.
The court notes in footnote 5 that where a settlement is structured upon a net payment to stockholders without an agreement on the amount of the maximum fee award that the defendants will not oppose, as in this case, the defendants have an incentive to oppose fee requests viewed as unreasonable in order to manage their total payments. By contrast, the court observed that: “Defendants are usually indifferent as to what percentage of a gross settlement is awarded to plaintiffs’ counsel because their exposure is capped at the gross amount.” The court expressed its preference for fee applications subject to adversarial inquiry in order to provide the court with a better record regarding the quality of the benefit achieved in the proposed settlement and the related Sugarland factors.
The court also observed at footnote 6 that the case relied on upon by the defendant “did not conduct any analysis and reached no conclusion concerning whether fee awards should be based on the net or gross value of a settlement.” Referring to five recent settlements cited by the defendants, the defendants argued that the Court of Chancery traditionally has awarded attorneys’ fees between 20% and 25% of the value of settlements exceeding $65 million. Defendants suggested that the midpoint of that range supports an award of $15.75 million in fees in this case, which is equal to 22.5% of the $70 million net settlement fund, not including reasonable expenses.
Issues Presented:(1) Whether the fee award should be calculated on a net or a gross basis; and (2) the appropriate amount of the fee.
The decision announced that: “This court traditionally has granted fee awards in common fund settlements based on the percentage of the gross settlement value” (though no cases were cited in support of that statement.) For example, the fee awards in each of the five settlements relied on by the defendants exceeded $65 million and defendants describe them as based on the gross value of the settlement. Indeed, the court observed that the “defendants were unable to identify a single case in which this court made a considered judgment to award a fee based on a percentage of the net recovery that stockholders would receive in a common fund case.”
One observation that can easily be made based on the court’s statement that a fee award is based on the “gross settlement value” in a common fund settlement, is that it is counterintuitive. For example, if the gross value of settlement is calculated by adding the net payment to the class to the attorneys’ fees payable, the plaintiff is obtaining an award based at least in part on a percentage of the attorneys’ fees that are paid to him, which seems as if the plaintiff is receiving a double advantage.
The court reviewed the familiar Sugarland factors, namely: (1) the results achieved; (2) the time and effort of counsel; (3) the relative complexities of the litigation; (4) any contingency factors; and (5) the standing and ability of counsel involved. Of course, the benefit achieved is the most significant factor. The court explained that the quality of the benefit depends on several factors, including whether the business judgment rule applied in which case the plaintiffs presumably would have received no recovery had they gone to trial. On the other hand if the entire fairness standard had applied, “the benefit takes on a different complexion.” Of course, the settlement was reached without either side knowing what standard of review ultimately would apply and which financial experts would be more persuasive at trial.
The court cited to the recent decision in the matter of In re Activision Blizzard, Inc. S’holder Litig., highlighted on these pages here, which awarded between 22.7% to 24.5% of cash and non-monetary benefits achieved in a case involving “complicated legal issues and the need for extensive discovery,” including over 800,000 pages of discovery documents and 23 fact depositions taken in a compressed schedule.” The court also noted other cases at footnote 11 in which it was observed that: “Delaware case law supports a wide range of reasonable percentages for attorneys’ fees, but 33% is the very top of the range of percentages.” The court concluded that 23.5% of the gross value (approximately $91.5 million) of the settlement, inclusive of expenses, would be the appropriate award in this case. The court also spent several pages at the end of this letter opinion on a separate discussion explaining why it rejected the request for a share of the fee award by New York counsel who engaged in related litigation involving the challenged transaction.
ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member LLC, C.A. No. 5843-VCL (Del. Ch. July 9, 2012). In this opinion the Court of Chancery awarded attorneys’ fees, based on a fee-shifting provision of the LLC agreement, of more than $3.2 million. The recent Chancery decision on the merits of this case, on which the award of fees is based, was highlighted on these pages here.
Whether the fee-shifting provisions of an LLC Agreement justified an award of fees to the prevailing party for litigation conducted simultaneously in four different courts.
Short Answer: Yes.
The background details of this case were highlighted in a May 2012 decision by the Court of Chancery linked above, which addressed the merits of a dispute involving the interpretation of several related LLC Agreements, and the decision of the Court to reform the related LLC Agreements based on a scrivener’s error.
One key issue in this case was whether the four separate litigations in four separate courts could be combined for purposes of awarding fees to the prevailing party.
In describing the procedural genesis of this case, the Court said that: “logic and efficiency cried out for a single forum, preferably with a decision-maker knowledgeable about Delaware law. Scion eschewed the efficient course.” Instead of agreeing to litigate all the issues in Delaware, the defendant filed three separate additional actions in three separate federal courts in Illinois, Wisconsin and Florida. Motions to stay were filed, briefed and decided in each of the federal cases. Motions to dismiss were filed, briefed and decided in all four cases. Motions for summary judgment were filed, briefed and decided in all four cases. Multiple courts heard motions on discovery in pretrial issues. At least two emergency applications were made to the Court of Chancery for an expedited decision to help avoid a “multi-jurisdictional train wreck.”
The prevailing parties sought $3.2 million in fees and costs for the successful effort in the Court of Chancery, as well as in the three separate federal cases. After the Court of Chancery decision in May of 2012, the parties dismissed the three federal cases by stipulation. [By comparison, a separate decision from the Court of Chancery also within the last few days, awarded fees based on the bad faith exception to the American Rule, under different factual circumstances, as summarized here.]
When parties by agreement have consented to a shifting of fees that requires a non-prevailing party to reimburse the prevailing party for reasonable fees and costs in connection with enforcement of an agreement, the focus of the Court is: “principally on enforcing the parties’ agreement to make the prevailing party whole.” Prior decisions of the Court of Chancery have generally upheld such a provision entitling the prevailing party to fees, and the Court has found that such a provision: “will usually be applied in an all-or-nothing manner.”
Explanation of the Difference between “Good Faith” and “Fair Dealing” as Components of Fiduciary Duty, as Compared to the Implied Covenant of Good Faith and Fair Dealing
In the course of explaining why it would award attorneys’ fees under the fee-shifting provision of the LLC Agreements, the Court was called upon to discuss the basis of a claim for a breach of the implied covenant of good faith and fair dealing–and to compare the “good faith component” of that covenant, and the “fair dealing component” of such a claim, with the fair dealing concept under the fiduciary duty law of Delaware, and the good faith aspect of the fiduciary duty law of Delaware, and how those concepts differ. See Slip op. at 5-7.
The Court emphasized that fair dealing for purposes of the good faith and fair dealing covenant imposed on every contract in Delaware as an implied covenant is, unlike its fiduciary duty namesake under the entire fairness doctrine, a commitment to deal consistently with the terms of the agreement of the parties and the agreement’s purpose.
Likewise, the good faith component of the covenant of good faith and fair dealing does not envision loyalty to the other party to the contract, but rather: “Faithfulness to the scope, purpose, and terms of the parties’ contract. Both necessarily turn on the contract itself and what the parties would have agreed upon had the issue arisen when they were bargaining originally.”
In connection with its analysis, the Court also reviewed basic contract principles including Delaware’s recognition of “efficient breach” of contract and that the: “traditional goal of the law of contract remedies has not been compulsion of the promissor to perform as promised but compensation of the promissee for the loss resulting from the breach. ‘Willful’ breaches have not been distinguished from other breaches . . .” See footnote 6. Moreover, the Court emphasized that proving a breach of contract claim does not depend on the breaching party’s mental state.
The Court also emphasized that proof of fraud violates the implied covenant not because breach of the implied covenant requires fraud, but because “no fraud” is an implied contractual term. That is, the law implies that the parties never would have agreed to fraud as a term of an agreement.
The Court also recited the four situations when an at-will employee can claim a violation of the implied covenant. See footnote 8.
In discussing the way that the concept of fraud interfaces with a claim for breach of the implied covenant, the Court explained that proving fraud is simply one way of establishing a breach of the implied covenant of good faith and fair dealing, but not the only way. This is so, because proving fraud represents a specific application of the general implied covenant test; that is: “What would the parties have agreed to when bargaining initially?” Specifically, they would have agreed that fraud would not be allowed. The Court explained that the implied covenant of good faith and fair dealing is, in essence, a contract claim and not a tort claim.
The Court also cited to other decisions to support the view that even when separate actions and separate lawsuits were pending in different jurisdictions, if they were related to one essential dispute, then a fee award would be entirely proper that included those separate actions which were deemed to be one continuous piece of litigation, and the net result of all the actions resulted in the settlement of the differences of the parties.
Reasonableness of the Fee Award
The Court described the standards that would be used to determine the reasonableness of fee awards based in part on Rule 1.5(a) of the Delaware Lawyers’ Rules of Professional Conduct. As applied to the facts of this case, the Court reasoned that simply because the rates that one firm charges are higher does not make them unreasonable. In addition, the fact that an attorney for one party spent more than twice as many hours for the same task does not make that number of hours unreasonable. For example, the Court referred to the attorney for the prevailing party spending 67 hours to prepare for an expert deposition, and that at trial the prevailing attorney “destroyed” the credibility of the opposing party’s expert. The losing party, by contrast, was unshaken on cross examination and that party’s attorney spent less than half the number of hours (31) preparing for the expert deposition.
One of the many lessons that can be learned from this opinion, is that Delaware courts do not often second guess the amount of fees charged by attorneys in situations where the fees are awarded based on a fee shifting provision in an agreement, such as this case, or when they were awarded pursuant to the bad faith exception to the American Rule. See, e.g., Auriga case highlighted here, and the very recent Coughlin case, highlighted here.
Awarding $875,000 in attorneys’ fees and expenses for an action regarding the internal affairs of a Delaware corporation, Vice Chancellor Laster provided a roadmap of potential recovery in future cases. In re Emerson Radio Shareholder Derivative Litigation, C.A. No. 3992-VCL (Mar. 28, 2011). Read opinion here.
This summary was prepared by Ryan P. Newell of Connolly Bove Lodge & Hutz LLP.
After obtaining majority control of Emerson Radio Corporation (“Emerson”), The Grande Holdings Limited (“Grande”) became the subject of an inspection by the Emerson Audit Committee for transactions that allegedly benefited Grande’s subsidiaries at the expense of Emerson. As a byproduct of the audit, the Emerson board adopted a number of recommendations regarding financial controls and corporate governance. Two derivative actions were filed challenging Grande’s alleged related-party transactions. After document discovery, depositions, and motion practice, Grande agreed to pay $3,000,000 to Emerson which in turn agreed to implement augmented governance procedures for related-party actions. Plaintiffs sought $1.5 million in fees.
In Delaware, attorneys’ fees and expenses are awarded when a suit challenging actions related to the internal affairs of a corporation confers a benefit upon the stockholders. The measure of those fees and expenses falls within the discretion of the Court based upon factors set forth in Sugarland Industries v. Thomas:
(i) the amount of time and effort applied to the case by counsel for the plaintiffs; (ii) the relative complexities of the litigation; (iii) the standing and ability of petitioning counsel; (iv) the contingent nature of the litigation; (v) the stage at which the litigation ended; (vi) whether the plaintiff can rightly receive all the credit for the benefit conferred or only a portion thereof; and (vii) the size of the benefit conferred.
The Court awarded $875,000 in fees based on the following analysis.
Monetary Benefits Conferred
Where the benefit is quantifiable, the Court will generally “apply a ‘percentage of the benefit’ approach.” Where a case settles early and before trial (e.g., initial factual investigation, no depositions, no motions), the Court tends to award 10-15% of the benefit conferred. Where the case settles after some greater involvement (e.g., a number of depositions, motion practice), the Court tends to award 15-25% of the benefits conferred. The Court will award no greater than 33% – an amount reserved for cases that progress much further than discovery and perhaps go to adjudication.
In this case, counsel recovered $3,000,000 for the Plaintiffs by engaging in significant discovery – hundreds of thousands of pages of documents were produced, eleven depositions were taken and two discovery motions were addressed. As a result, the Court deemed this to be in the middle tranche of cases where the award is generally 15-25% of the recovery. The Court started at 25% of the $3,000,000 award (or $750,000).
While the Plaintiffs obtained a number of corporate governance reforms, two facts mitigated the value of those benefits. First, the Audit Committee had already instituted many similar reforms. Second, many of the reforms were required by federal law and stock exchange standards. Estimating that the potential harm the corporate governance measures saved Emerson at $500,000, the Court applied the 25% cap to that amount to arrive at $125,000 for therapeutic benefits.
Time and Effort of Counsel
In considering the potential for a windfall, the Court placed a “cross-check on the reasonableness of a fee award” by considering the amount of hours worked. The Court held that 2,136 billable hours at roughly $410 per hour would “not confer an unwarranted windfall on plaintiffs’ counsel.”
Relative Complexity of the Litigation
The Court held that this case did not warrant an adjustment – up or down – for complexity.
The Court gave weight to the contingency risk endured by Plaintiffs’ counsel: “[u]nlike when entrepreneurial plaintiffs’ firms routinely file representative actions against mergers, knowing that the defendants’ ability to issue supplemental disclosures and the hydraulic pressure of deal closure will combine to create a ready-made settlement opportunity, plaintiffs’ counsel here did not get into the case with an obvious and well-marked exit in sight.” But for this risk, the Court would have considered an award reduction.
Standing and Ability of Counsel
With well-known practitioners, this factor did not require any adjustment.