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A recent Delaware Court of Chancery decision is essential reading for anyone who seeks to apply the exception to the attorney/client privilege known as the Garner exception. Salberg v. Genworth Financial, Inc., C.A. No. 2017-0018-JRS (Del. Ch. July 27, 2017). Garner is known to corporate litigation practitioners as an exception to the general prohibition on the production of privileged communications between attorney and client.

Key Principles

The Garner exception applies in certain circumstances where corporate fiduciaries who are defending claims brought against them by those to whom the fiduciary duty is owed, based on the application of a multitude of factors in which it is determined by the court that the documents otherwise withheld, should produce otherwise privileged documents.

The court in this opinion makes it clear that the application of the Garner exception is factually determinative, and even if all of the various factors apply, whether or not a fiduciary exception to the privilege will be recognized is within the discretion of the court.

The context of this case was a Section 220 demand made more complicated because it was preceded by a derivative action which was still pending at the time of this Section 220 case. During the pendency of the previously filed derivative action, a merger of Genworth was announced.  The Section 220 case sought records regarding the valuation of the pending derivative action as part of the decision to merge.

One of the factors that made it more challenging in this case for the application of the Garner exception, was the acknowledgement by the parties that they were seeking, at least arguably, in the Section 220 action, documents that they would not otherwise be entitled to obtain in the pending derivative action against the same company.

This opinion is must reading for anyone seeking to have a complete and nuanced understanding of the Garner fiduciary exception to the attorney/client privilege.  The court also discusses Delaware Rule of Evidence 502(b) in the context of the analysis, as well as the Delaware Supreme Court’s Section 220 decision in Wal-Mart Stores, Inc., in 2014, highlighted on these pages here, which endorsed the application of Garner, which had been applied for many years previously by the Court of Chancery.

In addition to the nine factors that the Garner case requires to be considered as informing the court about whether “good cause” exists, the Delaware courts have identified three of those as having particular significance. See footnotes 18 and 19.  Even though the Garner factors, including the three that the Delaware courts focus on, were arguably met, the biggest problem that the claimants faced in this case, and a key reason for the court’s decision, was that they were seeking to obtain in a Section 220 action what they otherwise would not be able to obtain through the previously filed and still pending derivative action.

The court emphasized that even if all of the Garner factors apply, they are not “talismanic” and that the court must use its discretion based on the unique circumstances of every case.  The court in this case was troubled that the documents sought would contain the mental impressions and assessments of the defendants and their counsel in the derivative action regarding the strengths and weaknesses of the derivative claims.  The company’s board would be understandably concerned that the production of those sensitive documents would give the plaintiffs an unfair advantage in the derivative action.  The general articulation of the Garner fiduciary exception recognizes that:

“Where the corporation is in suit against its stockholders on charges on acting inimically to stockholder interests, protection of those interests as well as those of the corporation and of the public requires that the availability of the privilege be subject to the right of the stockholders to show “good cause” why the privilege should not apply.” See footnotes 10 and 11.

The exception is intended to be difficult to satisfy and generally does not entitle the party to the mental impressions about trial strategy of the lawyers regarding the lawsuit at issue. In sum, the court refused to apply the Garner exception in this case.

Why this Case is Noteworthy: The Court of Chancery’s opinion in Laborers’ District Council Construction Industry Pension Fund v. Bensoussan, C.A. No. 1123-CB (Del. Ch. June 14, 2016), is the second decision from the Court of Chancery in two months that provides a reasonable basis for skepticism about whether, as a practical matter, plaintiffs’ attorneys should wait for the results of a Section 220 action before filing a plenary derivative suit. This case involves the popular Lululemon brand of athletic apparel, and allegations of insider trading at the company.

Overview: This opinion needs to be viewed in the context of a Chancery opinion issued last month styled In Re Wal-Mart Stores, Inc. Delaware Derivative Litigation, in which the court found that Delaware derivative litigation was barred due to a prior dismissal in another state of a derivative suit that was filed involving similar claims. The plaintiffs in that related litigation in another state, that was dismissed with prejudice, did not use Section 220. In the Wal-Mart case, as in the instant case, the Delaware plaintiffs waited until their Section 220 claims were litigated before filing their plenary action. By that time however, the litigation that was filed earlier in another jurisdiction, and which was not delayed by Section 220 demands, was dismissed. The Court of Chancery in this case found that the additional information that was obtained through the Section 220 action was not a sufficient reason to avoid the principles of issue preclusion, and claim preclusion, that prohibited the Delaware case from proceeding.

Readers should closely review the 40-page decision, but among several highlights include the following:

Procedural Background:

This litigation was preceded by two separate Section 220 actions. In one of those actions, after trial, the court largely rejected the request for books and records under Section 220. In the other Section 220 action that preceded this litigation, the court ordered the production of some documents but still a motion to compel was required because of a dispute about attorney/client privilege. That dispute resulted in a written opinion that was highlighted on these pages here. See In Re Lululemon Athletica Inc. 220 Litigation, Cons. C.A. No. 9039-VCP (Del. Ch. Apr. 30, 2015).

That decision on Section 220 issues was rendered approximately two years after the first Section 220 litigation was filed in Delaware as a prelude to the instant decision in the plenary case. My comments at the above link regarding the Section 220 opinion, and the shortcomings of Section 220 in general, apply here as well.

Key Takeaway:

The court found that simply because the plaintiffs and their counsel in the New York litigation did not first file a 220 action, or wait for a 220 action to conclude, that fact alone did not, ipso facto, make the plaintiffs in that derivative case inadequate representatives for that litigation. See page 32 and footnote 69 – 70 and accompanying text. See also footnote 75 referring to the Delaware Supreme Court opinion in Pyott, highlighted on these pages, which held that not using Section 220 prior to a derivative action does not create an irrebuttable presumption of inadequacy of representation.

The Delaware Court of Chancery published an opinion this week that interpreted a statute that gives stockholders a right to demand the “books and records” of a company, to include the right to demand electronically-stored information not only from the corporation, but also from its directors and officers. Amalgamated Bank v. Yahoo!, Inc., C.A. No. 10774-VCL (Del. Ch. Feb. 2, 2016). It also addresses the duties of directors in connection with reviewing and approving executive compensation packages. (Plus: it features quotations from a law review article I co-authored on Section 220, as noted below.)

The treasure trove of corporate law jewels in this opinion, weighing in at 74 pages, can easily justify commentary of similar length. Those who want to keep abreast of key Delaware corporate law principles need to make the time to read the opinion in its entirety, but for present purposes I will provide bullet points with highlights.

  • Although this decision includes a comprehensive analysis of the prerequisites for demands under Section 220 of the Delaware General Corporation Law (DGCL) regarding the right of a stockholder to obtain books and records of a company, a fuller understanding of this opinion can be be obtained by comparing it to other recent decisions on Section 220, including the recent Delaware Supreme Court ruling in Abbvie which rejected a Section 220 request based on an exculpatory clause in the corporate charter in that case, and which was highlighted on these pages. The Yahoo decision should also be juxtaposed with a decision a day earlier by Vice Chancellor Noble which limited the scope of records that were demanded by a director. See Chammas v. NavLink, Inc., C.A. No. 11265-VCN (Del. Ch. Feb. 1, 2016). The Chammas opinion directly addresses the rights of a director to books and records but is not as expansive in ordering emails or records of individual officers, and does not address ESI as the parties appear to have agreed on that issue. The Yahoo opinion should also be contrasted with the Supreme Court decision in the Wal-Mart case, highlighted on these pages, which required the production of extensive information regarding board deliberations, including an exception to the attorney/client privilege.
  • One of the most important reasons why this case is destined to be often cited, and deserves a prominent position in the pantheon of seminal Delaware decisions, is because, to my knowledge, it remains the first Delaware opinion to directly interpret DGCL Section 220 in a manner that explicitly requires the production of electronically stored information (ESI) based on the statutory language. Although the court lists quite a number of Delaware decisions in footnote 42 that have ordered the production of emails in connection with Section 220 requests based on the facts of those cases, as far as I am aware, this is the first Delaware opinion that expressly addresses the obligation of a company pursuant to Section 220 to produce ESI as compared to requiring the production of just emails. But I don’t think that prior cases explicitly interpreted the statute to require ESI production (which is broader than emails).
  • This opinion, consistent with it statutory interpretation, rejected the argument by Yahoo that inspection rights under Section 220 are limited to paper records. See page 20. In doing so, I am happy to say that the court in this opinion quoted from a law review article co-authored by yours truly which argued that the court should include ESI as part of the obligation to produce records under Section 220. See 37 Del. J. Corp. L. 163, 165 (2012), highlighted on these pages here.
  • Although the Wal-Mart decision referred to above required the production of various emails, that decision as I recall, is fact specific and did not expressly include in the same direct and comprehensive fashion as this opinion, with the detailed analysis and supportive reasoning that this opinion did, an interpretation of Section 220 as requiring ESI (which is broader than email only) to be included in a production of “books and records.”
  • Importantly for those needing to understand the scope of Section 220, this opinion also required the production of relevant personal emails by officers and directors to the extent that they were responsive to the demand (i.e., emails on a non-business, personal email account). See footnote 43.
  • Although there are hundreds of Delaware decisions interpreting Section 220, many of them highlighted on these pages over the last ten years, this opinion describes the prerequisites of Section 220 and the nuances and scope of Section 220 demands more thoroughly than any other Section 220 opinion that I can recall. If a person interested in learning about Section 220 were to read only one opinion on Section 220, in an effort to understand all of its nuances as requirements, this should be that opinion.
  • In connection with its discussion of Section 220, the court also provides advice to directors regarding their fiduciary duties when reviewing and approving an executive compensation proposal. See pages 42 and 43.
  • The court also clarifies that the prerequisite of needing a credible basis to allege mismanagement as a threshold requirement for Section 220 is not the same as requiring or assuming that one will prevail on such a claim, nor is the Section 220 standard whether it is reasonably conceivable that one could prevail on such a claim, as in a Rule 12(b)(6) motion.
  • Lastly, the court imposed a condition on the production that all the documents that the court ordered Yahoo to produce in this opinion will be incorporated by reference into any plenary complaint that is filed by the plaintiffs.

Supplement: California lawyer Keith Paul Bishop and the venerable Professor Bainbridge, observe that if Nevada law were to apply to this set of facts, the result would likely be much different.

In Re Lululemon Athletica Inc. 220 Litigation, Cons. C.A. No. 9039-VCP (Del. Ch. Apr. 30, 2015). This Delaware Court of Chancery opinion addresses important issues regarding the scope of documents (including emails) that a company must search for and produce after an order is granted pursuant to DGCL Section 220.

Discovery of Non-Employee Directors

Most noteworthy about this opinion is the court’s discussion of the scope of a search that is required – – or not, for emails of non-employee directors.  The court focused on documents that were in the possession and control of the company – – which was not likely to include non-employee director emails.  At footnote 22, the court provided a practical and useful description of the process used to search a company server for emails, which is not likely to include emails between non-employee directors because those emails would not ordinarily pass through the company server.  Footnotes 32 and 33 also discuss, without deciding, the presumption that production of company records does not necessarily or automatically include the records of directors.

Opportunity Averted

Importantly, the court declined at least by implication the opportunity to address the scope of a search for ESI that a company must perform in connection with production in a Section 220 case.  My inference was based in part on the fact that the court relied on the definition of “document” that was used by the plaintiff, as compared to the definition in the court rules of the word document.

ESI and Section 220

To my knowledge, neither the Court of Chancery nor the Supreme Court has directly addressed this issue of the scope of ESI needed to be searched or produced in connection with a Section 220 demand.  See law review article addressing this issue.

Garner Exception to Attorney-Client Privilege

Also noteworthy was the court’s discussion of the exception under the Garner and Wal-Mart cases for documents that are otherwise covered under the attorney-client privilege but still may be subject to production based on exceptions to that privilege, such as those situations when the data is not otherwise available in connection with breach of fiduciary duty claims – – under certain circumstances.

Commentary – Constant Refrain

A final note should be familiar to readers of these pages as a frequent refrain that I often include in commentary on Section 220 cases.  This opinion requiring further production pursuant to a stockholder demand for books and records under DGCL Section 220 comes two years after the first demand was made.

To put a sharper point on it, this case is one of many highlighted on these pages that support the observation that Section 220 demands are neither for the fainthearted nor for those without financial stamina.  The first Section 220 complaint in this consolidated matter was filed in May 2013.  In April 2014, one year later, a post-trial order required a production of documents in light of a credible basis to infer possible insider trading and poor oversight by the board.  In June 2014 a motion to enforce the order of April 2014 was filed due to deficiencies in production.  Now, nearly a year after that motion to enforce, and nearly two years after the first complaint under Section 220 was filed, we have a 38-page decision by the court.  I feel confident in predicting that additional time, money and effort will be required by the plaintiff to enforce the latest installment in this Section 220 saga.  That observation is not intended as a negative comment on anyone involved in this case, but is merely my conclusion of how the process of Section 220 works after reviewing hundreds of cases after nearly three decades.

This is the tenth year that we are providing our annual review of the key corporate and commercial decisions from Delaware’s Supreme Court and Court of Chancery. This year we decided to pick only the top five among the more than 200 or so opinions that we highlighted. We encourage readers to suggest cases that should be added (or deleted) from this list. Reasonable people may differ on our selections, and we could have added many more important decisions if we did not limit the list this year to five. Prior annual summaries are linked in the right margin of this blog. A revised version of this summary appeared as an article for the ABA publication called Business Law Today.

(The Supreme Court’s stately building in Dover is featured in the photo from the Court’s website.)Photo of the Supreme Court Courthouse in Dover Hyperlinks below lead to both a fuller synopsis and each slip opinion.

C&J Energy Services, Inc. v. City of Miami General Employees’ and Sanitation Employees’ Retirement Trust, Del. Supr., No. 655/657, 2014 (Dec. 19, 2014). This Delaware Supreme Court opinion is noteworthy because it clarifies the version of fiduciary duties known as the Revlon standard that apply to a board of directors when they are selling their company, or there is a change in control. A shorthand reference for this opinion is that: a formal auction is not required to satisfy the Revlon standard. It also features a rare reversal of the Court of Chancery, and clarifies the standard that Chancery must follow when granting a mandatory injunction.

ATP Tour, Inc. v. Deutscher Tennis Bund, Del. Supr., No. 534, 2013 (May 8, 2014). The Delaware Supreme Court decided certified questions of law from the District of Delaware regarding whether it was consistent with Delaware law for a bylaw provision to provide for shifting attorneys’ fees to an unsuccessful plaintiff pursuing intra-corporate litigation. Short Answer: Such a bylaw provision is generally enforceable subject to equitable exceptions. This opinion has generated copious commentary among academics and others. Legislation addressing the issues in this opinion is expected to be considered in the Delaware Legislature during its 2015 session that ends in June.

Wal-Mart Stores, Inc. v. Indiana Electrical Workers Pension Trust Fund IBEW, Del. Supr., No. 614, 2013 (July 23, 2014). This Delaware Supreme Court en banc opinion requires Wal-Mart to produce documents about an alleged bribery scandal involving their Mexican subsidiary. Even though the initial focus of this case was on DGCL Section 220 and what documents a stockholder of Wal-Mart could demand, the most noteworthy aspect of this decision is that for the first time the Delaware Supreme Court directly addressed and recognized an exception to the rule that documents protected by the attorney/client privilege do not need to be produced. It is referred to as the Garner exception after a case of that name from the Fifth Circuit.

In this case, the Delaware high court ruled that the well-established attorney/client privilege does not apply to bar production, or the privilege is subject to an exception, if a stockholder needs the otherwise inaccessible information to sue a director for breach of fiduciary duty. A similar analysis was applied to documents otherwise protected by the work-product doctrine. This opinion will have lasting importance for corporate and commercial litigators regarding this topic.

Kahn v. M & F Worldwide Corp., Del. Supr., No. 334, 2013 (March 14, 2014). The Delaware Supreme Court affirmed the Court of Chancery’s decision granting summary judgment to the defendants under the business judgment standard of review (and not the entire fairness standard) where the controlling stockholder, MacAndrews & Forbes, conditioned its offer upon the MFW Board agreeing, ab initio, to two procedural protections: approval by both a Special Committee and by a majority of the minority stockholders.

In Re Rural Metro Corporation Stockholder Litigation, C.A. No. 6350-VCL (Del. Ch. Mar. 7, 2014). The Court of Chancery found RBC Capital Markets LLC liable for aiding and abetting the breach of fiduciary duties of directors by advising simultaneously Rural/Metro Corp. on the value of the company in connection with a sale to Warburg Pincus LLC, while other bankers at RBC were pitching their services to Warburg in an effort to gain fees by helping Warburg finance the same deal. In a subsequent opinion, substantial damages were assessed against RBC.

SUPPLEMENT: We are thrilled and honored that the venerable Professor Stephen Bainbridge, one of the nation’s top corporate law scholars and a favorite of Delaware courts and this blog, has graciously linked to this post on his blog, along with a very flattering description. It doesn’t get much better than this for someone who makes his living practicing corporate litigation.

The National Association of Corporate Directors publishes a magazine called Directorship. They published my article on the recent decision of the Delaware Supreme Court in the Wal-Mart case, highlighted on these pages, which recognized an exception to the attorney client privilege when a stockholder sues a member of the board of directors of a company and there is no other method to obtain the requested information.

McReynolds v. Trilantic Capital Partners IV, L.P., C.A. No. 5025-VCL (Del. Ch. Sept. 23, 2010), read opinion here.

Short Overview

The Delaware Court of Chancery rejected the argument of certain limited partners of an investment fund who filed suit to assert that they should be entitled to "back out" of the investment fund they joined, which was formed as a limited partnership, and avoid a capital call, based on their unsuccessful allegations that they were misled into believing that the fund would always be supported by Lehman Brothers, the major investment banking firm that famously failed after the L.P. was started, and after which the capital call was triggered. This is one of many recent Chancery cases that deal with hedge funds or other investment entities in which one or more of the investors try to avoid their obligations to contribute, or who otherwise attempt to extract themselves from the investment partnership.

Issues Addressed

The three arguments on which the limited partners based their efforts to extricate themselves from the partnership, each of which the Court rejected, involved the following issues:

1) Was there a "supervening frustration" that relieved them of their contractual obligation?

2) Was there a "mutual mistake" that allowed them to avoid their contractual duty to make payments?

3) Did the Texas Securities Act give them the ability to "back out" of the deal?

Highlights of Court’s Legal Reasoning   

The doctrine of supervening frustration can be invoked:

“[w]here, after a contract is made, a party’s principal purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made.”  Restatement (Second) of Contracts § 265 (1981).  The doctrine is generally limited to cases where “a virtually cataclysmic, wholly unforeseeable event renders the contract valueless to one party.” 
Wal-Mart Stores, Inc. v. AIG Life Ins. Co., 872 A.2d 611, 620 n.35 (Del. Ch. 2005) (quoting Sage Realty Corp. v. Jugobanka, D.D., 1997 WL 370786, at *2 (S.D.N.Y. July 2, 1997)), aff’d in part, rev’d in part on other grounds, 901 A.2d 106 (Del. 2006); cf. Restatement (Second) of Contracts § 265 cmt. a, illus. 1-4 (1981).

The Court added that “the doctrine does not apply if the supervening events were reasonably foreseeable, and could (and should) have been anticipated by the parties at the time of contract.” The Court explained that “by parity of reasoning, the doctrine cannot apply if the events in question were actually foreseen, anticipated by the parties, and explicitly provided for at the time of contracting.”

The Court reasoned that in this case the claim of supervening frustration was based on an event that the parties foresaw and specifically provided for in the LP Agreement–that is, Lehman’s disassociation from the fund. Moreover, the agreements specifically contemplated a successive general partner in the event of Lehman’s exit. Thus, because the LP Agreement contemplated and addressed the possibility that Lehman would disassociate from the fund, the event was a known or foreseeable risk to which the doctrine of supervening frustration could not apply.

Mutual Mistake

The Court explained that under the doctrine of mutual mistake, a party can rescind an agreement if: (1) Both parties were mistaken as to a basic assumption underlying the agreement; (2) The mistake materially affects the agreed-upon exchange of performances; and (3) The party adversely affected did not assume the risk of mistake.

The Court explained that a claim for mutual mistake must rest on the basic assumption about the contract. The analysis is comparable to claims for supervening frustration. Thus, based on the prior reasoning, it was not plausible that the continuing involvement of Lehman was a basic assumption underlying the agreement.

Assumption of Risk

Moreover, mutual mistake was not available because the plaintiffs assumed the risk of Lehman having financial trouble. Under Delaware law, a party assumes the risk of mistake where: (1) “The risk is allocated to that party by contract; (2) The party enters the contract knowing that he has limited knowledge about the relevant facts or treats that knowledge as sufficient; or (3) The Court assigns the risk to the party because it is reasonable to do so.” As applied to this case, the plaintiffs had limited knowledge but regarded that knowledge as sufficient and still decided to invest. Therefore, mutual mistake is not available.

Due to its limited applicability to readers of this blog, we will not include a discussion of the Court’s analysis of the Texas Securities Act. Regardless, that discussion did not change the conclusion of the opinion, in which all the arguments of the plaintiff were rejected.

 

Wal-Mart Stores, Inc. v. AIG Life Insurance Co. (Del. Ch. Dec. 12, 2006), read opinion here.

 In this Chancery Court case, the “clean-up doctrine” of equity court jurisdiction was discussed. The court exercised its discretion to retain jurisdiction based on its familiarity with the long history of this case and despite only one remaining claim being common law fraud and not equitable fraud. Footnotes 1 through 3 include the citations to prior court opinions over the long history of this case from both the Chancery Court and the Delaware Supreme Court. Thus, the motion to transfer to the Superior Court was denied.

In Wal-Mart Stores, Inc. v. AIG Life Insurance Company, download file, the Delaware Supreme Court addressed claims that have now been reviewed twice each by the trial and appellate courts in Delaware. The high court reversed the Chancery Court’s decision that dismissed an amended complaint.
The Supreme Court found that the amended complaint adequately alleges a claim of fraud in pleading that AIG sold Wal-Mart a product that was an economic sham designed to create enormous tax deductions and that AIG did so knowing that their product was flawed and without disclosing that those flaws jeopardized the favorable tax treatment that formed the basis of the deal. Page 8 of the decision, which is available at the above link, provides the three citations to the three prior reported decisions.
Although reversing the trial court, the Delaware Supreme Court did agree with the Chancery Court that Wal-Mart failed to state a claim under the doctrine of commercial frustration which excuses future performance under a contract only as follows:
“where, after a contract is made, a party’s principle purpose is substantially frustrated without his fault by the occurrence of an event the non-occurrence of which was a basic assumption on which the contract was made, his remaining duties to render performance are discharged, unless the language or circumstances indicate to the contrary.”
In addition, the Supreme Court agreed with the Chancery Court that there was no fiduciary duty and no fiduciary relationship created by the transaction between the parties,as the court defined them, and cited to authorities discussing when a fiduciary relationship would be created, despite labels such as “agent”. In this instance, the court agreed that the relationship with the insurance company and Wal-Mart was a “normal, arm’s-length business relationship.”
The Supreme Court also discussed the law of equitable fraud.
(see below link for completion of summary).

Continue Reading Equitable Fraud Found But No Fiduciary Relationship and No Commercial Frustration of Contract

Prof. Ribstein has a post that analyzes the competition among countries in Europe as a location for businesses to incorporate, in the manner that some say U.S. states compete. He asks whether London is the Delaware of Europe or the Wal-Mart of Europe for that purpose. He maintains that the competition among jurisdictions for corporations is not based on fees, “it’s based on lawyers”. Moreover, he concludes that: “…someday in the not distant future Delaware’s competition will not be Washington, as Mark Roe has suggested it is now, but London.” Here is the link:
Ideoblog: Corporate charter competition in Europe