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This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.

The Delaware Court of Chancery recently granted a Sahara Enterprises Inc.  investor’s books-and-records demand to know how the allegedly underperforming investment company was being run after finding that the directors’ and officers’ duty to manage includes keeping accessible records of what they did, in Woods v. Sahara Enterprises, Inc., C.A. No. 2020-0153-JTL (Del. Ch. July 22, 2020). A more concise list of takeaways about this case also appears on these pages.

Vice Chancellor J. Travis Laster’s July 22 memorandum opinion said Section 220 of the Delaware General Corporation Law does not require the trustee of The Avery L. Woods Trust to specify why she needs to value her Sahara shares in order for valuation to serve as a proper purpose for inspection.

Background

He said after a 2001 reorganization, Sahara, a privately held Delaware corporation with its headquarters in Chicago, functions as a holding company that owns 99 percent of the stock of investment company Sahara Enterprises LLC and the LLC’s managing member SMCO, holds the other 1%.  That left SEI owning none of its investments directly, the court said.

SEI reported its revenue and costs bundled with the sister firms, allegedly making it difficult for trustee Avery L. Woods to determine why SEI consistently underperformed the market and whether the cost of managing the investments was inflated by “paying compensation to directors, officers, and employees to manage the managers who manage its investment portfolio.”  She also suspected lack of oversight and mismanagement.

After receiving a fraction of the information she demanded as a stockholder, Woods filed a books and records action in Chancery in March which Sahara said should be dismissed because it was only a holding company and SMCO made the investment decisions and kept the relevant records.

Court’s Analysis

The Vice Chancellor said one of Wood’s purposes is to value her shares and, “valuation of a stockholder’s investment in a corporation, particularly where the corporation is privately held, has long been recognized as a proper purpose under 8 Del. C. § 220.”

He rejected Sahara’s argument that Woods failed to show she actually had a proper purpose and “the mere incantation of an accepted ‘valuation’ purpose in a private corporation is [not] sufficient.”  That position is “contrary to Delaware law,” because it “would require that a stockholder establish both a proper purpose (valuing shares) and an end use for the resulting valuation,” the court said.

Woods also established a reason to investigate wrongdoing, and “inspecting the company’s books and records can help the stockholder to ferret out whether that wrongdoing is real and then possibly file a lawsuit if appropriate,” Vice Chancellor Laster ruled.

Although the company’s poor performance, without more, has not been sufficiently protracted or extreme to draw an inference of wrongdoing, the tactical position that Sahara took during the litigation points to conflicts that might bolster Wood’s case, he said.

Sahara argued that it had none of the operating records Woods demanded because those functions were the province of SMCO and that it had no control over SMCO — or even access to its records.

First, the court said, that position conflicts with Sahara’s statements to shareholders that the reorganization would have no effect on the management of their assets or their access to records of the company’s operation.

Second, the court said, by representing that Sahara did not have any responsive books and records, it created a credible basis to suspect that Sahara’s “directors have abdicated their statutory responsibilities.”  If Sahara’s board of directors relied on SMCO, then the Sahara board “should have, at a minimum, books and records documenting the board’s good faith reliance on and active oversight of SMCO.”

At a minimum, the board owes duties of care and loyalty, so even if it delegates some of its authority, it retains the duty of oversight, which would include record-keeping to show that it fulfilled that function, the Vice Chancellor ruled.

Regarding which documents must be produced for each category’s stated purpose, he said they must be “essential and sufficient to [its] stated purpose.”

How directors and senior officers are compensated and whether they are the beneficiaries of any related-party transactions are basic facts that stockholders are entitled to know and investors are entitled to know how their fiduciaries are taking money out of the corporation, the Court said. “A stockholder should not have to point to a valuation purpose or assert suspicions about corporate wrongdoing to be able to learn how much money the directors and senior officers are receiving.”

In addition, the vice chancellor said Sahara’s annual reports did not make clear who the various officers and directors listed worked for and investors are entitled to know (i) who the Sahara senior officers are, (ii) how much compensation they receive, and (iii) whether Sahara has entered into related party transactions with any officers or directors.

“The Trust’s desire to know this information is itself a proper purpose,” and the Trust is entitled to a court order for the production of any documents from the allied companies that their controllers could “access in the normal course of business,” he said.

Allegations are commonly made that representations outside the four corners of the parties’ agreement about a merger or similar deal were untrue, and the buyer relied to his detriment on them. A recent decision from the Delaware Court of Chancery addresses the types of provisions in an agreement that could bar such claims for misrepresentation based on extra-contractual statements or omissions. In FdG Logistics LLC v. A&R Logistics Holdings, Inc., C.A. No. 9706-CB (Del. Ch. Feb. 23, 2016), the court allowed claims to proceed based on the absence in the parties’ agreement of a provision that restricted the representations on which the buyer relied only to those contained in the agreement.

Key Takeaways:

  • The starting point of an analysis about whether claims based on extra-contractual statements or omissions will be barred, must be the precise wording of the representation clauses and the integration clause in the applicable agreements. This starting point explains why the recent decision in Prairie Capital barred fraud claims based on alleged extra-contractual statements, but the instant opinion allowed such claims to proceed.
  • Another factually determinative aspect of an analysis of the issue is whether the promises about relying only on the warranties in the agreement are expressed from the point of view of the buyer. That is, in order to bar claims based on statements outside the four corners of the agreement, the provision in the agreement must “reflect a clear promise by the buyer that it was not relying on statements made to it outside of the agreement to make its decision to enter into the agreement” (citing Anvil, 2013 WL 2249655, at *8) (emphasis in original).
  • The court in the instant opinion recognized that an opposite conclusion was reached in dismissing fraud claims based on extra-contractual representations in the Prairie Capital case. But unlike in a similar case called Anvil, the court in Prairie found that the provisions at issue in that matter: “reflected an affirmative expression by the aggrieved buyer that it had relied only on the representations and the warranties in the purchase agreement.” Slip op. at 27. See also n. 55 (quoting exact language of the agreement).
  • In the instant opinion, the court distinguished Prairie Capital, and found the critical language was similar to the Anvil case to the extent that key language was missing from the integration clause and the representation provisions that did not include an affirmative expression by the buyer of: (1) specifically what it was relying on when it decided to enter the merger agreement or (2) that it was not relying on any representation made outside of the merger agreement. Instead, the representations in the instant matter were disclaimers by the selling company of what it was representing and what it was not representing. Moreover, in the instant opinion the court determined that the integration clause did not contain a clear statement by the buyer disclaiming reliance on extra-contractual statements.
  • The court relied heavily on the reasoning in the Abry case which underscored the strong public policy against fraud and the unwillingness of the court to bar a contracting party from asserting claims for fraud unless that contracting party “unambiguously disclaims reliance on such statements.”
  • The court referred to the point made in the Prairie Capital case that the disclaimer language need not include any “magical words,” but the disclaimer must be made from the perspective of the party who is making the claim in order to preclude fraud claims for extra-contractual statements.
  • The court noted the important fact that the buyer in the Abry case did not seek relief based on extra-contractual representations, but instead amended its complaint to premise its claims solely upon alleged misrepresentations in the agreement itself.

Free Supplemental Commentary: A complete understanding of this opinion and the key issue it addresses, requires a familiarity with and a comparison of the recent Chancery opinion that dealt with an identical issue in Prairie Capital III, L.P. v. Double E Holdings Corp., 2015 WL 7461807 (Del. Ch. Nov. 24, 2015), highlighted on these pages. Also, in order to master this issue, one needs to be familiar with two other cases listed in this post. The only practical way to distinguish between the cases is the precise wording of the integration clauses and the representation clauses in the agreements considered by these cases, regarding whether the provisions sufficiently and specifically expressly disclaimed reliance on extra-contractual statements, or if the agreement confined the universe of reliance in an affirmative manner to the four corners of the agreement. See Abry Partners V, L.P. v. F & W Acquisitions LLC, 891 A.2d 1032 (Del. Ch. 2006); and Anvil Hldg. Corp. v. Iron Acquisition Co., Inc., 2013 WL 2249655 (Del. Ch. May 17, 2013). See also cases cited at footnotes 47 and 48 of the FdG opinion.

Other Noteworthy Principles of Law for Corporate and Commercial Litigation:

  • The court rejected claims based on the Delaware Securities Act because the buyer did not establish the requisite factual nexus between the challenged merger and Delaware, needed to trigger an application of the Act. The court rejected as unreasonable the arguments that the Act applied in this case because to do so would lead to the “bizarre result” of converting a blue-sky statute intended to regulate intrastate securities transactions into one that would regulate interstate securities transactions. In addition, the court rejected the use of a statute allowing for the parties to agree that Delaware law would apply as a way to bootstrap an application of the Act.
  • That statute referred to is useful to know about – – independent of this case: Section 2708 of Title 6 of the Delaware Code allows parties to choose Delaware law to govern their agreement to provide certainty to the parties who are subject to jurisdiction in Delaware, to ensure their choice of Delaware law will be respected. The statute was intended to preempt the analysis in the Restatement (Second) of Conflict of Laws, that there exists a substantial relationship between the state and the parties, and that the application of the law of Delaware would not be contrary to any fundamental policy of the state. A prerequisite for the application of the statute is that the contract must involve $100,000 or more.
  • As part of this opinion, the court also granted summary judgment to the seller based on the terms of the agreement for payment of a tax refund that was earned prior to the merger, but received by the buyer after the merger. The court did not address, and apparently none of the parties raised the issue of, whether a claim for payment of money was outside the scope of the equitable jurisdiction of the Court of Chancery.

Transdigm Inc. v. Alcoa Global Fasteners, Inc., C. A. No. 7135-VCP (May 29, 2013).

Issue Addressed: Does a buyer’s disclaimed reliance on representations and warranties outside of the stock purchase agreement bar the buyer’s claim for fraudulent concealment of material information?

Short Answer: No.

Brief Discussion: This is a dispute between parties to a stock purchase agreement (“SPA”). TransDigm is the parent company of McKechnie Aerospace Investments, Inc. and McKechnie Aerospace (Europe) Ltd.  McKechnie USA was the sole shareholder of Valley-Todeco, Inc., and McKechnie UK was the sole shareholder of Linread Ltd. ( the “Fastener Subsidiaries”).  The buyer/defendant Alcoa Global Fasteners, Inc. (Alcoa”) purchased all of the outstanding shares of the Fastener Subsidiaries pursuant to an SPA executed on January 28, 2011.  The SPA contained language about disclosure of information and reliance.  In particular, Section 5.8 of the SPA stated in relevant part:

Buyer has undertaken such investigation and has been provided with and has evaluated such documents and information as it has deemed necessary to enable it to make an informed decision with respect to the execution, delivery and performance of this Agreement and the transactions contemplated hereby. Buyer agrees to accept the Shares without reliance upon any express or implied representations or warranties of any nature, whether in writing, orally or otherwise, made by or on behalf of or imputed to TransDigm or any of its Affiliates, except as expressly set forth in this Agreement. 

One of Linread‘s most important customers, Airbus, had a contract with Linread covering the period January 1, 2005 to December 31, 2008, which was later extended to December 31, 2012.  During due diligence, Alcoa asked Transdigm specific questions to “understand the scope of Linread‘s business with Airbus and the strength and potential for future success of the Linread–Airbus business relationship.” Unbeknownst to Alcoa, Transdigm was having issues with Airbus about pricing and the future of the Airbus business and “[a]lthough TransDigm had information at that time that would have been responsive to Alcoa‘s questions, TransDigm intentionally did not reveal some of that information in its responses.”  Indeed, it was not until after the SPA was executed that Alcoa learned that Airbus was unhappy about pricing and that McKechnie UK‘s CEO verbally offered (and Airbus had accepted) a 5% discount on all lockbolts purchased under the Airbus Contract starting on January 1, 2012.  In addition, Airbus indicated that it “seriously was considering moving 50%–55% of its lockbolt business to a European competitor.”

While Alcoa claimed that Transdigm engaged in fraud related to the transaction or misrepresented certain facts in the SPA, it was TransDigm that filed suit seeking reformation and breach of contract on issues unrelated to this motion.  Alcoa counterclaimed alleging, among other things, concealment of material information and misrepresentation in the SPA.  Transdigm then filed a motion to dismiss those counts in the counterclaim.  Alcoa responded by arguing that while in Section 5.8, Alcoa admittedly disclaimed reliance on any extra-contractual representations, the claim for concealment was not based on any extra-contractual representation by TransDigm. Rather, it arose from the intentional and affirmative concealment of material facts and Section 5.8 did not preclude such a claim. 

Holding:

The Court agreed with Alcoa, finding that the counterclaim stated a prima facie claim for active concealment based on the allegations regarding, among other things, conversations between Alcoa and Transdgim where Transdigm representatives were specifically asked about payments relating to Airbus and Transdigm.  Those representatives not only failed to say anything about the 5% discount or the threat of Airbus moving its business, they “made an effort to hide this information.”  As the Court noted:

Based on these allegations, it appears reasonably conceivable at this preliminary stage of the litigation that Alcoa could prove that the TransDigm representatives who attended the January 6, 2011 meeting were apprised of the information allegedly known to Costello and Brown, among others, and that they intentionally omitted or concealed information from Alcoa. Alternatively, it is also reasonable to infer that, if the TransDigm representatives who attended the January 6, 2011 meeting did not know of the discount and potential loss of Airbus business, their ignorance—and resultant inability to inform Alcoa—was due to the active concealment of the information by Brown and others. Thus, the Counterclaim adequately alleges fraudulent and active concealment of material information.

The Court concluded that Alcoa “conceivably could prevail on its claim for fraudulent and active concealment of material information.”  As a result, the Court denied Transdigm’s motion to dismiss those claims but granted Transdigm’s motion to dismiss the misrepresentation claims.

Paron Capital Management LLC v. Crombie, C.A. No. 6380-VCP (Del. Ch. May 22, 2012).

Issue Addressed: Whether the breach of fiduciary duty owed by a hedge fund manager to his partners entitles them to lost future earnings.

Short Answer: The Court found that the partners who were defrauded were entitled to lost future earnings and other costs associated with the formation and operation of a hedge fund that they were misled into joining based on false statements.  The Court also awarded plaintiffs injunctive relief requiring one of the founders of the hedge fund to destroy or return copies of the trading program used by the hedge fund.

Background Facts

This case was brought by two partners in a hedge fund, McConnon and Lyons, who were fraudulently induced to participate in the founding of Paron Capital Management LLC by James D. Crombie, the sole defendant in this action.  Crombie was pro se and did not appear at trial.  In this post-trial opinion, the Court found that Crombie developed the futures trading program around which Paron was founded but the trading program developed to trade futures contracts was a fraud.  The Court found after trial that Crombie misled McConnon and Lyons to form the LLC to manage a hedge fund product and client accounts using his futures trading program.

McConnon was formally a principal of a multi-billion dollar hedge fund based in London, and Lyons had worked as a senior investment professional before they formed Paron.

Despite extensive due diligence that the Court described as including a formal investigation and report by the international risk consulting firm, Kroll, Inc., and which also included a credit history, property records and employment history, the Kroll report “failed to raise any red flags about Crombie’s history or personal situation.”  The opinion describes a veritable tale of woe.  The ownership of Paron was structured to give Crombie a 75% ownership interest, McConnon a 20% interest and Lyons a 5% interest.

Procedurally, prior to the instant case, the plaintiffs filed a declaratory relief action requesting the removal of Paron as a manager pursuant to Sections 18-110 and 18-111 of the Delaware LLC Act, at Title 6 of the Delaware Code.

This action was subsequently filed the next day, on April 14, 2011, alleging fraud and breach of fiduciary duty.  The trial was on October 3 through 5 of 2011 at which Crombie failed to appear.  He filed for bankruptcy in February 2012 which stayed this action, but pursuant to a motion, the stay was lifted in February of 2012.  [An attorney for the plaintiffs was quoted as saying that judgments for fraud are not discharged in bankruptcy.]

Analysis

In its description of the elements that need to be proved by a preponderance of the evidence to establish fraud, the Court explained that:  “Fraud need not take the form of an overt misrepresentation; it also may occur through concealment of material facts, or by silence when there is a duty to speak.”  The Court found that plaintiffs proved by a preponderance of the evidence that Crombie committed fraud against them.  The Court described in detail the fraudulent account documentation that constituted false representations of fact that Crombie made to the plaintiffs.  The Court explained the reasonableness of the reliance by plaintiffs on the misrepresentations, including a description of the extensive due diligence that they performed.

The Court also described the breach of the traditional duties of loyalty and care.  See fn. 22 (citing caselaw for the statement of Delaware law that:  “In the absence of a contrary provision in the LLC Agreement, LLC managers and members owe traditional fiduciary duties of loyalty and care to each other and to the company.”)  The Court observed that:  “A director will breach his fiduciary duty of loyalty where he knowingly disseminates false information that results in corporate injury or damage to an individual stockholder.”  See fn. 25.

Damages

Plaintiffs claimed that the full extent of their injuries resulting from the fraud and breach of fiduciary duty by Crombie was at least $44 million in the form of reliance damages, mitigation damages and lost earnings.  The majority of this amount resulted from the lost earnings of McConnon.  The Court awarded over $700,000 for reliance damages that included the due diligence investigation, legal expenses related to the loans made to Paron, travel expenses, legal and accounting fees related to the formation of Paron and related costs.

The Court also awarded litigation costs for damages related to the legal fees, expert costs and other costs incurred to mitigate the damage caused by the fraud of Crombie such as legal fees incurred in connection with regulatory proceedings against Paron and Crombie and foreclosing on collateral provided by Crombie for the loan involved.

Legal Expenses as Form of Damages

The Court cited to Restatement (Second) of Torts § 914 (1979), as an exception to the American Rule that allows recoupment where legal expenses were incurred as a direct consequence of fraudulent conduct.  At footnote 29, the Court cited to a Delaware decision which explained as follows:

“Whether characterized as an exception to the American Rule or as a rule in its own right, Section 914(2) of the Restatement, (Second) Torts, allows for the recovery of legal fees and costs from an earlier action where:  one who through the tort of another has been required to act in the protection of his own interest in bringing or defending an action against a third person . . .”

The Court, based on the foregoing analysis, granted mitigation damages of $752,133.

Lost Earnings

The largest portion of the award was based on lost future earnings that resulted from the stigma that was imposed on the plaintiffs and the ruination of their prospects for future employment in the financial services industry as a result of their association with Crombie, and the damage to relationships with their clients which effectively made them unemployable in their industry.

The Court relied on the testimony of the principal of an expert professional search firm as well as an analysis about future lost earnings by a certified public accountant.  The Court accepted testimony that McConnon would likely have been able to receive annual compensation between $3 million and $5 million per year but that as a result of him being tainted by association with the defendant, the expert testified that he could probably not find work that would pay him more than $300,000 per year.  As a result of the testimony, the Court awarded McConnon damages for lost earnings in the amount of $32,160,816.  The other plaintiff, Lyons, was awarded lost earnings of $1,892,305.

Practice Comments

This case is noteworthy for several reasons.  One is the rather unusual award in Chancery cases of “future lost earnings.”  The other noteworthy aspect of damages in this case is that legal expenses were awarded as a result of expenditures that were necessary to protect the plaintiffs due to the fraud of the defendant – – and not for the usual reasons such as the “bad faith exception to the American Rule.”

ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member LLC, C.A. No. 5843-VCL (Del. Ch. May 16, 2012).

Issue Addressed: Should a real estate joint venture agreement be reformed to correct a scrivener’s error in the provisions of an agreement that “departed from settled real estate practice and produced an economically irrational result.”

Short Answer: Yes.

Background Facts

Entities affiliated with ASB Capital Management LLC sued to reform the capital-event waterfall provisions in a series of agreements governing real estate joint ventures managed by the affiliates of the Scion Group LLC.  The mistakenly drafted provisions called for Scion to receive incentive compensation even if the joint ventures lost money.  Scion seeks to enforce the agreements as written, and its affiliates advanced counterclaims for breach of fiduciary duty and related claims.  This post-trial opinion found that the plaintiffs proved that their entitlement to reformation was established by clear and convincing evidence.  The Court found that the testimony of the Scion witnesses was “at best self-serving.”  On the other hand, he found that the testimony of each of the ASB witnesses was candid and credible.

The Court found that the expert witness of Scion could not offer any plausible justification for the mistakenly drafted terms of the agreement known as the waterfall provision. The joint ventures in this case involved student housing.  ASB relied on a large law firm to prepare the joint venture agreements and an experienced real estate partner initially began the drafting responsibility but later ceded much of the work to an associate.

The parties’ intent was for Scion to receive incentive compensation known as a “promote.”  It was intended to be a two-tier promote.  The correct language was in the wrong place.  One of the net results of this misplacement was that Scion would begin to earn its promote before ASB and Scion received back their capital–contrary to standard industry practice.  Therefore on a money-losing deal, Scion would still receive 20% of every dollar that ASB invested.

Despite the dramatic economic consequences of this mistake, apparently nobody reviewing the drafts commented on the change.  However, Scion did notice that the first-tier promote did appear in a draft in the wrong location and “he understood the favorable implications of the error for Scion” even though he admitted that Scion did not provide any consideration for the favorable treatment.

Moreover, the lead partner responsible for preparing the agreement did not recall whether she had read the two drafts involved before they were circulated, but then testified that she must not have done so, because she acknowledged that it was simply wrong.  Her associate conceded that as a young associate she lacked the experience necessary to understand the terms involved and she only learned of the mistake from the partner afterwards.  The critical (wrong) provision, known as the Sales Proceeds Waterfall, was signed off by the associate with the net result being that the first-tier promote came before the return of the invested capital of the members. In the fall of 2007, an amendment was made to other provisions that did not relate to the promote.

A subsequent joint venture was entered into, and while the partner was on vacation, the associate took the lead on drafting the agreement.  She copied the original agreement and then made deal specific changes on business terms which did not correct the mistake.  Everyone assumed that the original agreement reflected the deal terms that everyone had negotiated, and therefore, that provision was not reviewed carefully.  The partner did not review the agreement carefully before it was approved.

Subsequent agreements among the parties were entered into whereby the associate would electronically copy the original agreement and then only made deal-specific edits without fixing the substantive mistake.  All the lawyers and the parties finalized the subsequent agreements again while assuming that it was correct, and not reviewing the provisions with the mistake.

The Court found that the brothers who controlled Scion were aware of the mistake but because it was to their benefit did not notify anyone.  One of those brothers, who was a lawyer, stayed “knowingly silent” about the mistake.

Several years later, in June 2010, Scion exercised a put right in one of the agreements.  At that point the venture was underwater and was worth less than what ASB had contributed in capital.  Based on the mistake, Scion would receive a gain of 282% and ASB would have a loss of $14 million or roughly 30%.  Without the mistake, Scion would have suffered a proportionate loss comparable to ASB.  Scion exercised a similar put right in other joint venture agreements with the parties that resulted in a similar substantial gain that was approximately 328%.

Analysis

The Court explained the concept of equitable reformation which involves the Court’s power to “reform a contract in order to express the real agreement” of the parties involved.  The Court explained that there are two doctrines that allow a reformation:

“The first is the doctrine of mutual mistake.  In such a case, the plaintiff must show that both parties were mistaken as to a material portion of the written agreement.  The second is the doctrine of unilateral mistake.  The parties asserting this doctrine must show that it was mistaken and that the other party knew of the mistake but remained silent.”

Regardless of which doctrine is used, clear and convincing evidence must be presented by the plaintiff to demonstrate that the parties came to a specific prior understanding that differed materially from the written agreement.

Reformation requires that there be a “specific prior contractual understanding” that conflicts with the terms of the written agreement, and that prior understanding “provides a comparative standard that tells the Court of Chancery exactly what terms to insert in the contract rather than being put in the position of creating a contract for the parties.”  Moreover, the prior understanding “need not constitute a complete contract in and of itself.”  Handwritten notes can constitute a prior specific understanding.  See Restatement (Second) of Contracts, § 155 cmt. a (1981).

In this case, the Court found that an e-mail (prior to the agreement being signed) reciting the terms of the deal, and an e-mail agreeing to those terms, formed the necessary “specific prior contractual understanding.”

The Court also relied on a term of art in the industry known as a “promote” which contemplates the return of invested capital and refers to a share of the profits from a project.  The Court found that the parties operated based on an understanding to use the established industry meaning of the word “promote.”

The Court concluded that there was a mistaken belief that the relevant provision reflected the correct terms.

The Court discredited the testimony of Scion, and found credible the ASB witnesses.

Knowing Silence of Party/Lawyer

The evidence also established the “knowing silence” of a principal of Scion, who also happened to be a lawyer, and who was aware that the provisions were mistakenly scrivened but intentionally remained silent. The Court did not address the legal ethics issues raised by this finding nor were the professional responsibility issues referenced elsewhere in the opinion. It is worth underscoring that the court found that a principal of Scion was a sophisticated real estate attorney with significant real estate joint venture experience, and the court determined that he provided less than credible testimony and that “he intentionally remained silent in an effort to capture an undeserved benefit for Scion.”

In connection with the attempt by Scion to take advantage of the scrivener’s error, the Court explained that:

“Delaware law states that the knowledge of an agent acquired while acting within the scope of his or her authority is imputed to the principal . . . It is the general rule that the knowledge of an officer or director of a corporation will be imputed to the corporation . . . This basic principal of agency law applies with equal force to LLCs.”

Thus, the knowledge of the representatives of Scion was imputed to Scion.

Failure to Read

The Court rejected the affirmative defense of Scion that “failure to read an agreement is no defense.”  The Court explained that:  “Delaware law does not require that a senior decisionmaker . . . read every agreement in haec verba.”  See fn. 2.

The Court also explained that failure to read the agreements before approving them would not bar equitable reformation because:  “Reformation is not precluded by the mere fact that a party who seeks it failed to exercise reasonable care in reading the writing . . ..”  (citing Restatement (Second) of Contracts § 155 cmt. a. See fn. 3 (citing cases that support this as the majority rule.)

The Court explained the difference between “avoidance” and reformation.  Unlike avoidance, an agreement subject to reformation is not voidable.  Equitable reformation does not void an agreement but rather corrects an error by conforming the as-written document to the agreed upon understanding.  See Restatement (Second) of Contracts § 157 cmt. b.

The Court also explained why ratification was not appropriate as an affirmative defense.  Likewise, the Court rejected the defense of unclean hands.

The Court also awarded attorneys’ fees pursuant to the contractual provisions of the parties in favor of ASB as the prevailing party.

UPDATE: This Chancery decision was appealed and on May 9, 2013, the Delaware Supreme Court upheld the reformation holding but reversed and remanded on the issue of fees because, in part, Delaware’s high court reasoned that the fees were not “incurred” in this case, as that term is used on the fee shifting provision of the applicable agreement (in light of the firm handling the case for free to avoid a malpractice claim), therefore, the trial court should determine on remand if there is another basis to award fees.

Supplement: Doug Batey on his LLC Law Monitor provides helpful commentary about the case.

Thanks to Mack Sperling of the North Carolina Business Litigation Report, we have a  very recent decision by a New York Court, applying Delaware law, holding that the business judgment rule was satisfied in the "fire sale" [my words] of Bear Stearns to JP Morgan. The decision, here,  was submitted to the court in North Carolina (mentioned below) hearing the Wachovia/Wells Fargo litigation that involved similar issues. 

Recall as noted here the decision of the Delaware Chancery Court a few months ago to stay the Delaware case involving the merger of Bear Stearns, and deferring to the pending related Bear Stearns case in a New York court in what was perhaps a sui generis procedural decision.  Here’s how Mack Sperling introduces the New York court’s Bear Stearns opinion:

… the Bear Stearns board did not breach its fiduciary duty in its quick approval of the merger with JPMorgan and in agreeing to the deal protection provisions that it did, including selling 39.5% voting control to JPMorgan: "The financial catastrophe confronting Bear Stearns, and the economy generally, justified the inclusion of the various merger protection provisions intended to increase the certainty of the consummation of the transaction with JPMorgan." (slip op. at 32).

Also on Friday, December 5, 2008, as reported by Mack Sperling here, the North Carolina Business Court found that the business judgment rule supported the merger of Wachovia and Wells Fargo that was arranged in similarly unusual circumstances in light of the economic turmoil that in very short order saw some of the country’s largest financial institutions "go under" or need "bailouts".

Prof. Gordon Smith comments here on the "fire sale"(?) at $2 per share of Bear Stearns on Sunday night to JP Morgan, with apparent pressure from the U.S. Treasury Department and the Federal Reserve Bank [despite statements days earlier that the value of the stock was much, much higher], and the application to the situation of Delaware corporate law. For example, did the Bear Stearns board of directors meet their Revlon duties to get the highest price? Also, if they were insolvent, did the directors fulfill their duties to creditors (some observers said that the only other option was bankruptcy). The good professor cites to a Delaware Chancery Court case that applied the Business Judgment Rule  to an apparently similar situation where a board was forced to choose between bankruptcy or another unpalatable option. See Odyssey Partners, L.P. v. Fleming Companies, Inc., 735 A.2d 386 (Del. Ch. 1999).

Prof. Larry Ribstein also comments on the situation here, citing to his prior writings on the issues.

Kevin LaCroix comments here on the inevitable lawsuits that have already been filed v. Bear Stearns.

UPDATE: In light of the recent increase in the price of Bear Stearns’ stock and JP Morgan’s stock, Prof. Smith updates his analysis here, with reference to the Delaware decisions in  both Quickturn and Omnicare, wondering aloud how, if at all, the Fed’s pressure and involvement  to get the deal done would impact the legal analysis by a Delaware court of the applicable fiduciary duties of the Bear Stearns’ board.

UPDATE II: Here is another update from Prof. Gordon Smith, including a link to his interview by the WSJ Law Blog (the comments to which are in parts entertaining and educational.)

UPDATE III: Here is an update on NYT’s Dealbook blog that indicates a possible drafting error in the agreement by JP Morgan’s lawyers, regarding JP Morgan’s duty to guarantee Bear Stearn’s liabilities forever, and that might  be one reason JP Morgan quintupled its offer to $10 per share (which in part will allow them to correct this term in the agreement, as well as "save" the deal in light of pending shareholder suits and recent threats by some to force a bankruptcy.) Prof. Smith has more on the guarantee issue here.

UPDATE IV: Prof. Larry Ribstein discusses applicable Delaware case law to the updated facts here, and Prof. Bainbridge discusses same here, including reference to updates by Prof. Smith.

Gildor v. Optical Solutions, Inc., download file. This Chancery Court decision involved cross motions for summary judgment. A preferred shareholder attempted to assert his preemptive rights to buy preferred shares issued by a privately-held company.
The main issue was whether or not the company gave proper notice to the shareholder as required by the agreement that gave him preemptive rights. The shareholder did not receive actual notice until after the issuance and the company argued that he waived the preemptive rights that he had bargained for in the Shareholders Agreement. In essence, because the agreement on which his preemptive rights were based, did not include a current address, even though the company had a current address in its records, the court determined that the company breached the agreement by not properly notifying the shareholder and resting on the mistaken belief that it had complied when it learned that notice did not reach the stockholder, Gildor, at the address to which the notice was sent.
The court reasoned that the company was required to make better efforts to comply with the notice provision, which was not literally possible, but required reasonable efforts to at least use the other addresses in the records of the corporation. Although the agreement required notice to be provided pursuant to the address in the agreement, the agreement did not include an address and the court concluded that

“issuers who create contractual ambiguity about the method of notice bear the proportionate costs of their own drafting infelicities by undertaking reasonable efforts to provide actual notice.”

The court did not rely on the “implied duty of good faith and fair dealing” because the court was hesitant to alter the dynamics of the bedrock principle of the freedom of contract by imposing duties that two sophisticated parties did not provide on their own.
The court also emphasized that specific performance was only available at the discretion of the court and required a showing that a legal remedy would be inadequate. However, it did note that when the stock of a private company is not available in the market, is unique or has unique value, that specific performance has been held to be appropriate (citing Amaysing Tech. Corp. v. CyberAir Communications, Inc. 2004 WL 1192602 (Del. Ch. 2004)).
In sum, it was not sufficient for the company to send two notices that it knew were sent to outdated addresses.
This calls to mind an article in the Sunday New York Times of July 9, 2006 by Linda Greenhouse at page 5 of Section 4. She was describing a recent decision by U.S. Chief Justice John G. Roberts, Jr. in which he wrote a majority opinion that found that the State of Arkansas denied due process to a homeowner by seizing and selling his house for non-payment of property taxes without taking reasonable steps to notify him of the risk he was facing. Chief Justice Roberts wrote in that case that “in response to the returned form suggesting that Jones [the homeowner] had not received notice that he was about to lose his property, the state did – – nothing.” Similar common sense logic and reasoning was used in the Gildor case. See generally a recent Delaware Supreme Court decision, summarized here, which addressed the issue of “when a mailed letter is presumed to be received by the addressee” in a different context than the Gildor case.

Several recent Delaware decisions, as noted on these pages earlier this week here, and commented on here, have added to the case law that still only amounts to a relatively modest body of law in Delaware, interpreting the phrase: “reasonable efforts” and various permutations on that phrase, often found in post-closing earn out disputes but prevalent in other contract disputes as well. A Delaware Court of Chancery decision two days ago has added again to the jurisprudence on this topic.

In the opinion styled In Re Oxbow Carbon LLC Unitholder Litigation, C.A. No. 12447-VCL (Del. Ch. Feb. 12, 2018), Delaware’s equity court published a 178-page magnum opus that has already been the subject of articles in Bloomberg and other legal publications. Prior Chancery decisions during the course of this hotly litigated case have been highlighted on these pages, and those rulings also provide background color. The opinion provides a comprehensive analysis of a factually complex dispute involving the billionaire William Koch and contractual rights of a minority member of an LLC in which Koch owned a majority. The post-trial tome deserves a robust synopsis, but in this short post I will only focus on the small aspect of the titular topic.

The following bullet points should entice readers to consult the full opinion if they need to know the latest iteration of Delaware law on these issues:

  • The court relied on Delaware Supreme Court precedent (n. 602) applying “commercially reasonable efforts” to “impose an affirmative obligation on the parties to take all reasonable steps to complete a transaction.”
  • Koch testified at trial that the Reasonable Efforts Clause involved required each party to “act in good faith to do what it takes….”
  • The court found support in the record to conclude that Koch spent resources and energy to thwart the sale instead of using reasonable efforts. See Chancery opinion in WaveDivision cited at note 614 and accompanying text.
  • This decision is also notable for its exemplary explanation and application of the following key Delaware concepts often involved in corporate and commercial litigation:
  • (i) the implied covenant of good faith and fair dealing;
  • (ii) unclean hands; and
  • (iii) interpreting an LLC Agreement in a manner that avoids an inequitable result.