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.

Corporate lawyers have a unique opportunity to influence American companies to benefit by practicing the ethical standards their mission statements and codes of conduct espouse, a Villanova Law School professor told a gathering of Delaware’s bench and bar recently.

After a two-year pandemic pause, jurists and attorneys returned to the Hotel DuPont in Wilmington for the 36th Annual Francis G. Pileggi Distinguished Lecture in Law to hear Business Ethics: What Everyone Needs to Know,’ presented by J.S. Nelson, an Associate Professor at the Harvard Business School and an Associate Professor at Villanova Law School.

Nelson began by popping what she identified as numerous myths about ethics

Compared to the statutes and rules that corporate lawyers deal with, ethics is rather esoteric

Ethics–essentially, man’s instinct to do the right thing–is not a theoretical subject, but is rather the foundation for the formulation, interpretation, application and enforcement of laws, Nelson said.  “Ethics is nothing like what you think it is.”

Ethics are just a matter of subscribing to a set of principles

It’s more complicated than that because humans have a dual nature regarding ethics, she pointed out.  On one hand, they proudly endorse certain values and behaviors and believe they are ethical, but on the other, they are very susceptible to pressure from certain institutions and situations to compromise or suspend even fervently held values and principles—often with famously disastrous results.

The people who said they were “just following orders” during the Holocaust were unique

Nelson told the group that extensive behavioral studies have repeatedly produced the exact opposite conclusion: regardless of ethnic, cultural or religious background more than two thirds of test subjects will yield to consistent unified pressure to join with an institution or group’s program –when the program directly contradicts the subject’s core ethical principles.

She said this dynamic applies in the corporate world when employees confront a corporate culture that tolerates or even promotes lax quality control, poor safety or working conditions, gender inequality or sexual harassment or questionable financial practices.  They will often do what they must to get along in the world in which they find themselves.

Ethical management does not produce a better bottom line.

Actually, in the long run, a management that provides good working conditions with equal pay, benefits and opportunities and prioritizes quality and safety over short-term operating cost savings will attract and retain more engaged, efficient staff, enjoy greater profits, and “won’t have to worry about where the next scandal will be coming from,” Nelson predicted.

But to have that positive proactive effect, the institution must present a consistent unified position against even small ethical wrongs, because it’s all too easy for a company’s effect on ethics to reverse and snowball in the negative direction, she said.

The Boeing example

For example, Nelson said, the Boeing Company had a stellar safety record until its management and board decided to create a higher passenger capacity version of its workhorse 737 jetliner without a complete redesign.  Instead, they opted to essentially hang bigger engines on its wings to lift the greater weight and when that caused a tippy fore/aft balance problem, they devised a computer program to help pilots compensate, but the program had deadly flaws that allegedly caused two crashes with the loss of all aboard, she explained.

That triggered an FAA investigation that grounded the entire 737 MAX fleet for 20 months and a successful shareholder suit in the Delaware Chancery Court that claimed Boeing’s directors were liable for lax safety that caused large financial losses. In Re the Boeing Company Derivative Litigation, No. 2019-0907-MTZ opinion issued, (Del. Ch. Sept. 9, 2021).

As this blog has reported, ethical failure allegations played a key role in Vice Chancellor Morgan Zurn’s Sept 9, 2021 landmark ruling which found plaintiffs’ derivative director oversight claims met the tough pleading standards of the Delaware Supreme Court’s Marchand ruling with well-supported allegations that a majority of the directors are likely liable for Boeing’s billions of dollars in losses and penalties. Marchand v. Barnhill, 212 A.3d 805 (Del. 2019).

Importantly, Vice Chancellor Zurn’s ruling repeatedly pointed to the Marchand standards in finding that Boeing’s directors:

  1.  Got no regular safety information on the 737 MAX or any of its planes due to their “complete failure” to establish a committee or regular board reports on safety issues,
  2.  After the first crash, did not immediately investigate what caused the 737 MAX to repeatedly push its nose down in a series of disastrous dives at low speeds and instead virtually ignored the problem even though safety was a “mission critical” area,
  3. Intentionally misled federal regulators about the scope and seriousness of a computer pilot training program meant to help them use software that would allegedly minimize nose-down dives,
  4. Allegedly lied to the public and regulators about how comprehensive, how much in good faith and how quickly implemented their post-crash safety program was.
  5. Never pressed the CEO for more information or questioned his conclusions when he repeatedly told the board the 737 MAX was safe and blamed the crashes on pilot and maintenance errors.

But Nelson pointed out that rulings on alleged low points in corporate behavior often prompt positive changes in ethical standards, “and sometimes today’s ethics become tomorrow’s laws.”

In my latest article for the current issue of The Delaware Business Court Insider, I provide highlights of a recent Chancery decision that involved virtually no damages for non-compliance with a confidentiality provision. Courtesy of that publication, the article is reprinted below.

A recent noteworthy Delaware Court of Chancery decision should be kept handy by corporate and commercial litigators for its practical and persuasive analysis of noncompliant handling of confidential documents: AlixPartners v. Mori, C.A. No. 2019-0392-KSJM (Del. Ch. April 14, 2022).

Key Aspects of Decision

This litigation is based on the defendant’s departure from AlixPartners to work for a client of AlixPartners in Italy.

 

The court awarded virtually no damages for noncompliance with the confidential designation given to certain documents. The introductory paragraph in the court’s 58-page post-trial opinion includes a money quote that captures the essence of this decision. In connection with the end of his employment with the plaintiffs:

“… the defendant copied thousands of the plaintiffs’ confidential documents onto his personal devices. He did so to use them in a follow-on employment lawsuit in an Italian court [—he lived in Milan—], although he also used certain of the documents for other innocuous, personal ends—to update his curriculum vitae and email goodbyes to his former clients.” Slip op. at 1 (emphasis added).

 

One could infer that the court was less than enthused that plaintiffs “pressed on with their claims,” on this issue—notwithstanding the return of the documents defendant had copied other than those he needed for his separate employment lawsuit with the plaintiffs.

Key Background Facts

The defendant, Giacomo Mori, was a managing director in the Milan, Italy, office of AlixPartners.

Italian law applied to some aspects of this dispute and experts on Italian law testified that Mori had a right to take and use documents from AlixPartners that he needed for his lawsuit with AlixPartners about his departure. See AlixPartners v. Mori, 2019 WL 6327325 (Del. Ch. Nov. 20, 2019) (prior decision in this case addressing jurisdictional issues). See generally Slip op. at 20 and n. 92 (observing that the court often grapples with employment disputes that the parties make into partnership agreement disputes, citing a recent case as another example.)

Breach of Confidentiality Obligations

This post-trial opinion features an application of the Italian Constitution, as well as a discussion of decisions of various courts throughout Italy, in addition to Italian statutory authority and various opinions of experts on Italian law.

Importantly, regarding whether there was a defense to a breach of a confidentiality provision for Mori to use some of the documents in connection with his separate employment litigation, the court relied on Section 178(1) of the Restatement (Second) of Contracts for the statement of law that a promise or other term of an agreement is unenforceable in some instances on grounds of public policy. Section 178(3) identifies four additional factors to consider “in weighing a public policy against enforcement of a term.”

The court assumed that Italian law provided a strong public policy to permit Mori to use confidential documents for use in his Italian litigation, based on either Section 178(1) of the Restatement (Second) of Contracts, or Section 187(b) of the Restatement (Second) of Conflict of Laws, regarding the law of the state chosen by the parties to govern their contractual rights and which state has an applicable fundamental policy relevant to an issue in dispute. The court also cited to Williston on Contracts, Section 19:8.

Nonsolicitation

The court found no violation of a nonsolicitation clause, and employed reasoning that has widespread applicability. The court explained that a non-solicitation provision “should not be construed to prohibit a former employee from responding to unsolicited inquiries. Otherwise, a former employee would have to be on guard at every turn and possibly barred from responding to a host of acceptable communications.”

Trade Secrets Under Italian Law

The court determined that Italian law applied to the issue of trade secrets and that the Delaware Uniform Trade Secret Act does not have extraterritorial effect. The court emphasized the challenge it faced to independently test the parties’ Italian law contentions by being unable to conduct its own independent research in original Italian sources, and that it was entirely reliant on the information provided by the parties, one of whom appeared pro se. Therefore the court cautioned that the precedential value of its decision on Italian trade secret law should be understood to be limited to the facts of this case and the law presented by the parties. Nonetheless, the court regaled the reader with a discussion of multiple decisions of several courts throughout Italy that decided trade secret issues under Italian law.

Permanent Injunction and Damages Denied

The court provides the reasons why permanent injunctive relief was denied. Notably, an Italian court awarded the defendant in this case nearly $2 million against AlixPartners regarding employment claims.

The Court of Chancery awarded a mere $7 in nominal damages, which was the amount requested by the plaintiffs, and which for all practical purposes, as an economic matter, is the functional equivalent in the context of this case, of no damages awarded for the breach of confidentiality provisions.

 

The 36th Annual Francis G. Pileggi Distinguished Lecture in Law (named after the father of this blog’s primary author), is presented by The Delaware Journal of Corporate Law of Widener University’s Delaware Law School

This year’s topic is

Business Ethics: What Everyone Needs to Know

Professor J. S. Nelson
Visiting Associate Professor at the Harvard Business School
Associate Professor at Villanova Law School

Monday, April 25, 2022
8:00 a.m. Breakfast; 8:45 a.m. Lecture

Hotel DuPont, du Barry Room
11th and Market Streets
Wilmington, Delaware 19801

Many of the prior 35 Annual Distinguished Lectures have been highlighted on these pages.

One ethics CLE credit available in Delaware, Pennsylvania and New Jersey. The brochure is available at this link.

Online registration form available at delawarelaw.widener.edu/pileggi2022

For additional information or for accessibility and special needs requests, contact Carol Perrupato at caperrupato@widener.edu or 302-477-2178.

A recent decision of the Delaware Court of Chancery acknowledged longstanding precedent which prohibits a state court from enjoining proceedings in a federal court.  In Schwartz v. Cognizant Technologies Solutions Corporation, C.A. No. 2021-0634-LWW (Del. Ch. March 25, 2022), the court recited several well­-established principles barring it from issuing an injunction to interfere with a federal court proceeding–which should be compared to the many decisions that have been discussed on these pages over the last 17 years regarding the well-settled enforceability of forum selection clauses.

Extensive background facts about the underlying advancement litigation appears in a Reuters article that describes the dispute between the parties as “lurid”. Extensive commentary on advancement cases have appeared on these pages over the last 17 years, but this case provides an usual procedural twist.

Highlights:

  • The court relied on several United States Supreme Court decisions for the principle that a state court cannot enjoin proceedings in a federal court. See Slip op. at 7-11.  The court described it as “black letter law” that an anti-suit injunction was not permissible in this context.  Cf.  Suits to enforce Delaware forum selection clauses.
  • The court distinguished the enforcement of forum selection clauses involving cases in other state courts. See Slip op. at 12.
  • The court explained that the federal court where related litigation is pending is the court that will decide whether the forum selection clause before that court should be enforced, and cited several cases where federal courts have routinely enforced forum selection clauses.  See Slip op. at 13.

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.

Vice Chancellor Sam Glasscock recently declined to certify a class action challenge to an allegedly unfair side deal in Straight Path Communications Inc.’s 2018 sale to Verizon Communications Inc. until he scrutinizes the use of non-public information in stock trades of Straight Path and its parent by lead plaintiff representative candidates in the matter styled In re Straight Path Communication’s Inc. Consolidated Shareholder Litigation, No. 2017-0486, (Del. Ch. Mar. 11, 2022).

In the five-year-old Delaware Chancery Court litigation, the Vice Chancellor on March 11 rejected a motion to certify a class without a proper class representative.  And he said that determination could not be made without a detailed investigation into whether prospective representative plaintiff mutual fund The Arbitrage Fund had profited by intentionally misusing access to confidential information from the plaintiffs’ law firm.  Meanwhile, the plaintiffs and the court continue to look for a suitable class representative.

The court noted that although class representative qualifications under Chancery Rule 23(a) or (b) include factors of typicality, adequacy, commonality, and numerosity, here, “no motion is pending naming an adequate lead plaintiff.” Therefore, it said, the inquiry must still focus on whether TAF and its affiliates traded on non-public information, as so doing would be “incompatible with the circumspection expected of voluntary fiduciaries, and thus would make TAF an inappropriate lead plaintiff.”

The finest loyalty

That’s important, the Vice Chancellor said, because, “Using non-public information obtained as a fiduciary for personal gain is not consistent with the behavior expected of a self-designated fiduciary.” And as an appointed fiduciary, the representative plaintiff owes the class a “duty of the finest loyalty,”

The decision comes at a pivotal point in the litigation.  In a February 17 opinion, he had denied a defense motion for summary judgment and refused to dismiss Straight Path ex-shareholders’ charges that they were shortchanged by $600 million in the Verizon purchase because insiders at Straight Path and its parent, IDT Corp. likely breached a fiduciary duty by concocting a side deal that wrongly diverted a valuable company asset to themselves.  That brought the plaintiffs a step closer to winning a judgment or settlement—if they could get certified as a class. Straight Path Commc’ns Inc. Consol. S’holder Litig., 2022 WL 484420 (Del. Ch. Feb. 17, 2022).

Vice Chancellor Glasscock, in his March 11 ruling, compared the worthiness of several plaintiffs for the role of class representative and made some important distinctions concerning access to, use of and misuse of confidential information for profit in stock trades in the two companies central to the challenged deals in this litigation.

JDSI LLC

The Vice Chancellor noted that one investor fund, JDSI LLC, had dropped out of contention for the class representative after discovery revealed that it had, at various times, held short positions in IDT after receiving non-public information, which the court said would be “troubling’’ and “disqualifying if true,” because it is “inconsistent with the actions this Court expects of a volunteer fiduciary.”

TAF

He said TAF’s situation regarding improper trading allegations of misuse of confidential info is ”more attenuated” in that while TAF itself did not trade in IDT, it did trade in  Straight Path, and its affiliates traded in IDT and Straight Path.   “But it does not necessarily follow that TAF Affiliates were barred from trading in IDT, depending on their decisionmakers’ access to non-public information,” the Vice Chancellor wrote.  “Again, the pertinent inquiry is not merely whether the TAF Affiliates had direct access to non-public documents; the Court must also consider whether the TAF Affiliates had access to TAF’s counsel such that the TAF Affiliates indirectly could obtain non-public information.”

If TAF still seeks the class representative role an evidentiary hearing to determine whether the TAF Affiliates’ trades were improper will be required, he ruled.

But the Vice Chancellor noted that “written caselaw where the purported representative plaintiff trades in the company that allegedly suffered the injury is comparatively slim and tends toward a sale of shares” but the same general concerns apply, as elucidated by In re Celera Corporation Shareholder Litigation,  in which the sales occurred after “all material information regarding the lawsuit, settlement, and transaction were disclosed to the marketplace.” In re Celera Corp. S’holder Litig., 2012 WL 1020471, at *1 (Del. Ch. Mar. 23, 2012), aff’d in part, rev’d in part on other grounds, 59 A.3d 418 (Del. 2012)

Accordingly, the Celera court certified the representative, although with numerous warnings.

Intervenor-Plaintiff Ardell Howard

The court suggested that an intervenor plaintiff might provide an easier path to a class representative. Ardell Howard was approved as an intervener/additional plaintiff in the case in July 2021 and has expressed an interest in serving as class representative, he said.  The IDT defendants had previously said they would want to conduct some discovery into Howard’s suitability for this position.

Vice Chancellor Glasscock continued the class certification motion with respect to TAF with leave to supplement the record and asked the parties to “confer and inform me as to their preference for moving forward.”

In a recent Delaware Court of Chancery decision that addressed claims of breach of contract and fraud in connection with the sale of a business, the Court announced that Delaware law allows for sandbagging, which can be described as allowing a buyer of a business to sue for breach of a representation made in an agreement for the sale of a business even if the buyer knew that the representation was false–before closing–and when the agreement was signed.

In Arwood v. AW Site Services, LLC, C.A. No. 2019-0904-JRS (Del. Ch. Mar. 9, 2022), while acknowledging that the Delaware Supreme Court has not definitively ruled on this issue, the Court of Chancery expressed confidence in stating that Delaware is a “pro-sandbagging state” for purposes of allowing a buyer to bring claims for breach of contractual representations in an agreement against a seller of a business even if the buyer were aware of the claim prior to closing–and at the time that the buyer signed the agreement of sale.

This decision is consequential and noteworthy for the foregoing highlights alone, but there are also other notable aspects of this 113-page opinion that make it worth reading in its entirety.  For purposes of this short blog post, I will only provide a few bullet points.

Additional Selected Highlights

  • The Court defined sandbagging as referring colloquially to “the practice of asserting a claim based on a representation despite having had reason to suspect it was inaccurate.” See footnote 267 and related text.  The Court also explained sandbagging as “generally understood to mean to misrepresent or conceal one’s true intent, position, or potential in order to take advantage of an opponent.”  See Slip op. at 71.  See also footnotes 270-274 and accompanying text describing the etymology of the word and public policy issues implicated by the Court’s position.
  • The Court also observed that the parties are free to draft contract provisions to avoid sandbagging claims. See footnote 290 and accompanying text.
  • This ruling also instructed that a fraud claim in Delaware is the same as a claim for fraudulent inducement. Slip op. at 50.
  • In this lengthy opinion the Court chronicles in much detail the history of the deal from the first meeting of the buyer and seller through various iterations of the letter of intent, as well as through the extraordinary and unfettered access given to the buyer during the due diligence period (that helped to defeat a fraud claim),  and that may serve as a cautionary tale for drafters of agreements of sale.
  • This decision also features extensive analysis and commentary regarding the competing expert reports on damages, and why the Court relied more on one expert as compared to the other.

The recent Delaware Court of Chancery decision in Krauss v. 180 Life Sciences Corp., C.A. No. 2021-0714-LWW (Del. Ch. Mar. 7, 2022), addressed nuances of advancement law that will be useful to those who labor in the field of corporate litigation dealing with these issues that are crucial to officers and directors.

The key points of law that makes this decision blogworthy are twofold: (i) it serves as a reminder that some compulsory counterclaims may be eligible for advancement; and (ii) it reinforces the longstanding interpretation in Delaware of the phrase that serves as a prerequisite to providing advancement, with an origin in § 145 of the Delaware General Corporation Law, and which was used in the provision of the Bylaws at issue in this case–namely, whether the person seeking advancement was sued “by reason of the fact” that she was an officer.

Advancement has been a frequent topic of commentary on these pages over the last 17 years, and has been the subject of many articles and book chapters published by this writer.

Background:

Unlike the corporate charter involved in this case, the advancement provision in the Bylaws of the company involved did not require board approval for advancement to be given for certain types of proceedings.

Highlights:

Perennially, one of the more common defenses to a claim for advancement, and often the least successful argument–as in this case–is whether the prerequisite to the provision for advancement in the Bylaws was triggered to the extent that the litigation for which advancement was sought was prosecuted: “by reason of the fact that . . . [the plaintiff] is or was a director or officer of the company.”  See Slip op at 8-9 and n.32.

As the Court explained, the foregoing phrase is broadly interpreted by Delaware courts, and many published decisions have explained in many different ways why it is very easy to satisfy that condition of advancement, despite may failed attempts by companies to use it as a defense.  See Id. at 9-10.  See also footnotes 32-37.

Also noteworthy in this case is the reminder that the court will not typically make a determination at the advancement stage about an allocation between legal fees that must be advanced–and intertwined claims in the same case that are not subject to advancement.  But rather, the parties should follow the procedure in the Danenberg v. Fitracks  decision to make advancement payments based on the good faith allocation of the parties, and a final allocation will be made at the end of the case.  See Slip op. at 12 and footnotes 44-45.

Another noteworthy aspect of this case is the reminder that compulsory counterclaims are covered by the right to advancement when asserted to defeat or offset an underlying claim that is subject to advancement.  See Slip op. at 20 and footnote 74-81.

 

A recent Chancery decision provided three reasons why the first-filed rule, sometimes known as the McWane Doctrine, would not be followed, based on the procedural history and facts in the case styled: In re Lordstown Motors Corp. Stockholders Litigation, C.A. No. 2021-1066-LWW (Del. Ch. Mar. 7, 2022). The Court first explained that the McWane Doctrine applies with less force in the context of representative litigation.  The second reason the court provided for why the doctrine will not be followed in this case is that: even though a related federal action was first-filed, and concerns the same business combination–the parties, the claims, and remedy sought in that first-filed case are different.

The third and more important reason that the first-filed rule was not followed in this matter is because, as the court observed:  “This case raises emerging issues of Delaware law” regarding Special Purpose Acquisition Companies (SPACs.)

The Court added that although established doctrines of fiduciary duty law are far from novel, the Delaware Court of Chancery has had occasion to apply those principles in the context of a Special Purpose Acquisition Company [SPAC] and stockholder redemption rights just once (in a decision authored by the same vice chancellor who decided the instant case).

The court concluded that the essential role of the Delaware Court of Chancery in providing guidance in developing areas of Delaware law would be impaired if it were “to denude its jurisdiction because a federal securities action resting on similar facts was filed first.”  Slip op. at 2.

In a short letter ruling, with widespread applicability, the Court of Chancery explained in Paul Elton, LLC v. Rommel Delaware, LLC, et al., C.A. No. 2019-0750-KSJM (Del. Ch. Mar. 16, 2022), that typical indemnification provisions ordinarily:

“are presumed not to require reimbursement for attorneys’ fees incurred as a result of substantive litigation between the parties to the agreement absent a clear and unequivocal articulation of the intent.  This presumption prevents broadly written indemnification provisions, which may be intended only to hold the indemnitee harmless from claims brought by third parties to the contract, from swallowing the American Rule.  Thus, purely contractual indemnification provisions only shift first-party claims if the contract explicitly so provides.”

See Slip op. at 2-3.  See also footnotes 8-10.

A recent Court of Chancery decision underscores the difficulty, at least in Delaware, of attempting to disregard the separate existence of a legal entity, sometimes referred to as “piercing the corporate veil”—though in the case styled  Verdantus Advisors, LLC v. Parker Infrastructure Partners, LLC, C.A. No. 2020-0194-KSJM, Order (Del. Ch. Mar. 2, 2022), the goal was to “pierce the veil” and disregard the separate existence of a limited liability company. (Although this decision was in the form of an Order, as compared to a more formal Opinion, it remains permissible in Delaware to cite in briefs to an Order.)

We have written before about piercing the corporate veil on these pages, and have referred readers to a definitive book on the topic by this blog’s favorite corporate law professor, whose scholarship is cited by the Delaware courts: Prof. Stephen Bainbridge.

Highlights of the more noteworthy aspects of the pithy ruling in this matter include the following:

  • The Court explained that: “Veil piercing is a tough thing to plead and a tougher thing to get, and for good reason.” Order at 4 (citations omitted.)
  • In addition, the Court added that: “Delaware is in the business of forming entities, and so ‘Delaware public policy does not lightly disregard their separate legal existence.'” Id.
  • Five factors considered in determining whether to pierce the corporate veil are: (1) whether the company was adequately capitalized for the undertaking; (2) whether the company was solvent; (3) whether corporate formalities were observed; (4) whether the dominant shareholder siphoned company funds; and (5) whether, in general, the company simply functioned as a facade for the dominant shareholder.” Id. at 5. (citations omitted.) See n.14 (citing cases for the position that no single factor will suffice; and in order to apply the alter ego theory, the entity must “exist for no other purposes than as a vehicle for fraud.”)
  • Notably, the Court observed that most single-member LLCs don’t follow many formalities for the good reason that there are “few statutorily mandated formalities imposed on those entities.” Order at 5.
  • In conclusion, the Court noted that, in light of its reasoning and holding, it need not address the argument made that veil-piercing theories should be unavailable or extraordinarily limited in the alternative entity context. n.18.