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 ruled that Connecture Inc.’s Chairman of the Board and his affiliated investment company were not part of a control group accused of breaching their fiduciary duties by shortchanging shareholders in a go-private buyout of the web-based health insurance vendor in Gilbert v. Perelman, et al. No. 2018-0453-SG, memorandum opinion (Del. Ch. April 29, 2020).

Vice Chancellor Sam Glasscock’s April 29 memorandum opinion found board chairman David Jones Jr. and his investment affiliate, Chrysalis Ventures II, L.P., owed no duty to the minority as part of a control group because Francisco Partners GP IV Management Limited had a majority voting share without their holdings.

The Vice Chancellor defined corporate controllers as “stockholders who, through control of the majority of the voting shares (or otherwise) can seize the corporate machinery and turn it to their own benefit. When they do so, they control the entity; the property, in part, of the minority stockholders. In that sense, when they employ that control they too are fiduciaries.”

Applying Almond v. Glenhill

The opinion should be of interest to M&A specialists in that Vice Chancellor Glasscock sets out the reasons that, for purposes of this ruling, those two defendants are not part of the control group even though Securities Exchange Commission rules may include them in the “purchaser group.”

He used Chancellor Andre Bouchard’s 2018 Almond v. Glenhill Advisors opinion to explain when a transaction participant could be a necessary part of the control group – giving rise to fiduciary duties — even though, as here, its stock was not needed as part of a majority holding. But shared interests and goals are not enough to impart such duties. he said. Almond v. Glenhill Advisors LLC, 2018 WL 3954733, at *25–26 (Del. Ch. Aug. 17, 2018), aff’d Almond v. Glenhill Advisors, LLC, 224 A.3d 200 (Del. 2019).

History

Connecture Inc. a Delaware-chartered company based in Wisconsin that provides an online health insurance marketplace to connect health insurance consumers with providers, offered a series of private stock placements to raise capital between 2015 and 2017.

As a result of its purchases during this period, a group of Cayman Islands limited partnerships which the court collectively labeled “Francisco Partners” acquired a 56 % voting share of Connecture in 2017 – 68 % when combined with Jones and Chrysalis’ holdings.

In response to several abortive offerings by seven prospective suitors for Connecture, Francisco Partners – supported by Jones and Chrysalis — made an offer in late 2017 to acquire the remaining stock in a forced cash-out merger for $.30 cents a share.

According to Gilberts’ complaint, there was no provision for a minority vote on the buyout, but by that time, the board had decided to delist the stock from NASDAQ trading because of its failure to comply with listing requirements and the share price had dropped to $.17 cents.

The merger was finalized in April 2017, Gilbert’s suit was filed in June, and Jones and Chrysalis moved to dismiss

Not needed, not liable

Jones and Chrysalis owned a total of 11.2 percent of Connecture, which Francisco Partners did not need to force the buyout.

Vice Chancellor Glasscock found that whatever role Jones and Chrysalis had in the buyout, they could not have any control group fiduciary liability unless they were a necessary part of the control group and under Almond they could not be a part of that group unless their stock was needed to form a majority or they served some other role necessary to the transaction.

Almond requires one of two conditions, he said: “There must be an arrangement between the controller and the minority stockholders to act in consort to accomplish the corporate action, and the controller must perceive a need to include the minority holders to accomplish the goal, so that it has ceded some material attribute of its control to achieve their assistance.”

Liable as a director?

Neither of those conditions are present here, Vice Chancellor Glasscock said. He granted Jones and Chrysalis’ dismissal motions as to that charge.

As to the separate breach-of-duty charge against Jones for his actions as a director, the Court noted that Jones is protected from liability for violations of his duty of care by 8 Del C. § 102(b)(7) in an exculpatory provision that shields him unless there are particularized allegations of self-interest or bad faith.

In that light, he asked the parties to decide in the next week whether they would set out their arguments in briefs as to Jones’s liability as a director separate from his actions as an alleged control group participant.

A recent letter ruling from the Court of Chancery on a nuance of the law of advancement deserves to be remembered. The Court’s decision in Day v. Diligence, Inc., C.A. No. 2020-0076-SG (Del. Ch. May 7, 2020), is short but important due to its clarification of a finer point regarding the duty of a company to advance fees prior to the date of the undertaking required under DGCL Section 145(e).  The Court reasoned that an advancement obligation may cover fees incurred prior to the receipt of a requisite undertaking.

The multitude of highlights of advancement decisions that have appeared on these pages over the last 15 years provide extensive details about the intricacies of Section 145(e), as do the several book chapters I have written on the topic. This cursory post assumes a basic understanding of the Delaware law of advancement of fees for directors and officers pursuant to Section 145(e), and based on that assumption this pithy post provides the following quote from the Day case, that should be in the toolbox of every corporate litigator.

The Court held, after reciting DGCL Section 145(e), that:

Nothing in the language of the statute, or the policy implicit therein, limits advancement to sums incurred post-undertaking, to my mind. The Defendant, I note, has pointed to none. Nor has it cited to precedent….

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 grounded a GoPro Inc. investor suit over the troubled launch of the Karma camera drone for failure to show the directors faced liability for allegedly concealing product development and revenue problems that they knew would cause a major stock price drop in the matter styled In Re GoPro, Inc. Stockholder Derivative Litigation, No. 2018-0784-JRS, memorandum opinion issued (Del. Ch. April 28, 2020).

The Court’s April 28 memorandum opinion dismissed a consolidated breach-of-duty action because it failed to clear the pre-suit demand threshold hurdle by casting sufficient doubt that the directors could fairly review the charges either because of their action or inaction regarding the disastrous 2016 launch.

Not obliged to doubt

He found that the board, which got persistently optimistic development projections in the face of repeated setbacks, “was under no obligation to disclose what it did not know or did not believe to be true. Nor was it obliged to doubt the information it was receiving from GoPro’s management.”

The directors were not conflicted by a related federal securities suit over disclosures because they faced no liability in that action, and they were not beholden to CEO/founder Nicholas Woodman just because his 76% control of GoPro’s stock enabled him to remove them “at will,” the Vice Chancellor said.

According to the opinion, GoPro, a Delaware-chartered motion camera and software developer based in California announced early in 2016 that it would produce a drone to house the latest version of its HERO camera series; but it repeatedly delayed the launch due to production ramp-up issues, inventory shortages, abnormally high product returns and ultimately, a recall of the drone.

However, management’s revenue guidance remained unchanged during that period and the board eventually revised its estimate down from $1.5-$1.3 billion to $1.25-to $1.3 billion, but the company only generated $1.185 billion which resulted in a 12% stock price decline.

The securities action

That triggered a consolidated shareholder securities action in federal court in California claiming GoPro officers and directors hid an expected revenue shortfall through false and incomplete disclosures under Sections 10(b) and 20(a) of the Securities Exchange Act. Bielousov v. GoPro Inc., 2017 WL 3168522 preliminary settlement approved (N.D. Cal. Oct. 30, 2017).

Attorneys for those plaintiffs announced a tentative $6.75 million settlement in October 2017.

The derivative action

The Court of Chancery consolidated suit charged breach-of-duty, disclosure violations and insider trading on non-public information by some directors who exploited their non-public company information as first addressed in Brophy v. Cities Service Co., 70 A.2d 5 (Del. Ch. 1949).

By November, the full release of the Karma drone and Hero camera had been pushed back to December 2016 but even that promise was compromised by battery defects and supply chain problems in the first 2,500 drones that lowered GoPro’s 2016 revenues to $1.185 billion. Eventually the company issued a recall of the drones.

In May 2019, GoPro asked the Court to dismiss the combined Chancery suit for failure to first either seek board review of the charges or to show why the directors were too conflicted to do so.

Arguments for excusal

The Delaware plaintiffs argued that:

(1) a majority of the defendants faced a substantial likelihood of personal liability for allowing and failing to correct false statements,

(2) a majority of the board is beholden to Woodman,

(3) the directors would be conflicted about any suit against the Brophy defendants and

(4) the Bielousov action renders a majority of the directors interested.

The problem with those four arguments, the vice chancellor said, is that the plaintiffs lack sufficient factual particularity to support their false statement assertions “either as an affirmative choice to mislead stockholders or as a matter of poor oversight.”

There is ambiguity as to which type of claim they want to pursue, but whether they claim an intentional misrepresentation or a failure to supervise, the suit fails because of the deference of the business judgment rule and the protection of the exculpatory clause in the GoPro charter, the vice chancellor said.

That clause, authorized under 8 Del. C. § 102(b)(7), bars money liability for directors for any ordinary breach of the duty of care, and cannot be overcome without proof that the directors face a threat of liability, such as for a breach of the duty of loyalty; but only one member of the GoPro board – Woodman – is alleged to have personally made a false statement, the opinion says.

Nothing sticks

Even if the other directors acquiesced to Woodman’s alleged falsehood, that is not enough to support a claim of affirmative board misconduct, and it is well-settled that a controlling shareholder’s power to remove directors does not mean they lack independence from him, the Court wrote.

“Although plaintiffs throw everything against the wall, nothing sticks,” he said in granting the motion to dismiss. “While Plaintiffs urge the Court to infer scienter, the complaint pleads no facts that would allow a reasonable inference a majority of the board knew GoPro was misleading investors with any of its public statements during 2016.”

I’m happy to report that I am now the Managing Partner of the new Delaware office of the Lewis Brisbois firm, which has over 1,500 lawyers, in over 40 practice areas of the law, in over 50 offices. I’m very excited to share this exciting next chapter in my professional career. The Delaware Law Weekly published a nice article about my big move.

My new contact information is:

Lewis Brisbois, 500 Delaware Ave., Suite 720, Wilmington, Delaware 19801

francis.pileggi@lewisbrisbois.com

(office) 302-985-6002 and (cell) 610-457-0407

UPDATE: The esteemed Professor Bainbridge kindly linked to this post on his widely-read blog.

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 allowed the same shareholder who successfully challenged a 2015 Investors Bancorp Inc. director and officer compensation plan to pursue a new suit over a similar 2019 replacement plan adopted one month after the court approved the settlement of the first action in Elburn v. Albanese, et al., No. 2019-0774-JRS, memorandum opinion (Del. Ch. April 21, 2020).

Vice Chancellor Joseph R. Slights’ April 21 memorandum opinion found plaintiff Robert Elburn passed the tough pre-suit demand test by showing the IBI directors might not act impartially in response to his breach-of-fiduciary-duty charges because they had made a “quid pro quo” arrangement with two top officers that enabled the first suit’s settlement.

Corporate litigators should note the court’s rejection of the defendants’ novel argument that to clear the threshold demand hurdle, a suit must plead “newspaper facts” – i.e. who, what, when, where and how details of the alleged wrong – to satisfy the particularized pleadings requirement of Court of Chancery Rules 12(b)(6) and 23.1.

Not always fatal

Although such specifics might sometimes be required under Rule 9(b) to prove a fraud claim, “the lack of this ‘specificity’ when pleading either fraud or demand futility is not, de jure, ‘fatal’ to the claim,” and derivative plaintiffs usually have less access to the background of deals they challenge, the court said.

The April 21 decision was the second time Elburn’s sued over a $50 million IBI stock award and cleared the pre-suit demand hurdle.

The Chancery Court dismissed his challenge to the directors’ 2015 equity incentive plan that awarded stock to the employee directors – principally CEO Kevin Cummings and COO Domenick Cama – but the Delaware Supreme Court reversed and remanded, finding possible self-dealing that would negate the protection of the business judgment rule.  In re Inv’rs Bancorp, Inc. S’holder Litig., 177 A.3d 1208 (Del. 2017).

A settlement of the first suit, approved June 21, 2019, called for the two executives of the Delaware-chartered bank holding company based in Short Hills, New Jersey, to give back all of their awards and for the non-executive directors to return an average of 40% of theirs for a 75% total reduction

New award, new suit

But when the board adopted a replacement plan one month later restoring all of the two top officers’ awards, Elburn filed a new derivative action claiming the executives conspired with the other board members to forfeit all of their awards — allowing the others to keep about 60% of theirs in the pact.

In return, the quid pro quo provided that as soon as the settlement won court approval, the non-employee directors would disloyally adopt a replacement plan that essentially duplicated the scope of the top officers’ award, again damaging the shareholders, Elburn’s new derivative action alleged.

Elburn said although directors have latitude to award lavish compensation to top executives, both board actions included a fatal element of self-interest—in the new case, a pact that let the non-employee directors keep most of their money from the first plan in return for replacing the executives’ award.

Moreover, the board only hinted that it might consider additional stock awards in a proxy issued in advance of a 2019 director election and never updated that disclosure after adopting the costly and unwarranted replacement stock plan, the suit said.

A chance to prove quid pro quo

Vice Chancellor Slights said the plaintiff’s allegations are sufficiently particularized to give him a chance to substantiate his conspiracy theory, noting that Elburn specifically charges that the executives and board agreed to the quid pro quo pact before the settlement of the first suit.

However, “targeted discovery is likely to reveal rather quickly if the quid pro quo agreement alleged in the complaint was actually reached,” he said. “If it was not, defendants are likely to earn summary judgment.”

The vice chancellor denied defendants’ motion for summary judgment on the fiduciary duty claims for failure make a pre-suit demand, but he refused plaintiff’s request for summary judgment on his charge that the directors violated their disclosure duty through misrepresentations and omissions in their 2019 director election proxy.

He quickly dispensed with the charge that the proxy misled investors to believe the board had only begun to consider a new stock plan when in fact that decision was imminent at the time of the proxy.  The charge is “not enough to state a viable disclosure claim, much less carry his burden to earn summary judgment on that claim,” the vice chancellor said.

A material failure to supplement?

However, the disclosure claim that the directors failed to supplement the proxy to indicate that the board had approved the compensation plan may have been an omission – but was it material to the shareholders’ decision to vote for the incumbent directors, the court asked?

The answer to that question, it said in denying the motion, can be found in further discovery as to how much the shareholders understood and approved of the likely size and cost of a new stock compensation plan for their directors and officers.

He noted that “the cases plaintiff cites where this court has ordered new director elections involved far more serious malfeasance than the disclosure violations plaintiff has alleged here.”

Delaware law allows for non-signatories to be bound by a forum selection clause if a three-part test is met, and a recent Delaware Court of Chancery opinion provides an analysis of those factors while granting a motion to dismiss in Highway to Health, Inc. v. Bohn, No. 2018-0707-AGB (Del. Ch. April 15, 2020).

The most noteworthy aspects of this pithy decision are: (i) a reminder that Delaware enforces forum selection clauses; and (ii) that a non-signatory can be bound by a forum selection clause if a three-part test is satisfied. See footnotes 46-47 and accompanying text. The directors of a Delaware company sought a declaratory judgment against non-residents of Delaware regarding a dispute about stock-appreciation-rights (SAR) that, by contract, required the board to fulfill fiduciary duties towards the SAR holders.

Three-Part Test for Binding Non-signatories

The three-part test requires one to demonstrate that: (i) the forum selection clause is valid; (ii) the non-signatories are third-party beneficiaries; and (iii) the claims arise from their standing relating to the agreement. Slip op. at 15. The third element of the test was not satisfied based on the facts of this case because the agreement containing the forum selection clause was not the same agreement that gave rise to the substantive claims brought by or against the non-signatories.

Long-Arm Statute and Specific Personal Jurisdiction

This decision also features an analysis of the Delaware long-arm statute, and explains why the “specific jurisdiction” requirements under Section 3104(c)(1) of Title 10 of the Delaware Code were not satisfied because there was no relevant act that actually occurred in Delaware. The Court factually distinguished a case that found specific jurisdiction based on an amalgamation of factors that included: Delaware lawyers drafting the agreement at issue; a Delaware choice-of-law provision; and issues related to the sale of capital stock in a Delaware company. See NRG Barriers, Inc. v. Jelin, 1996 WL 377014 (Del. Ch. July 1, 1996).

Although the plaintiffs in this case did not avail themselves of the opportunity, the Court observed that limited discovery may be allowed in connection with the plaintiff satisfying its burden of proof to establish personal jurisdiction over defendants.

A recent Delaware Court of Chancery decision entertained a request for expedited relief in Delaware despite a New York forum selection clause, in part due to the unavailability of the New York Courts that were not fully operational due to the coronavirus shutdown. Francis Pileggi and Chauna Abner co-authored an article with an overview of the ruling in Conduent Business Services v. Skyview Capital, C.A. No. 2020-0232-JTL, Transcript Ruling at **33-34 (Del. Ch. Mar. 30, 2020), for the Delaware Business Court Insider in its recent edition. The full article appears below.

“While New York Court System is ‘Unavailable’ Delaware Court of Chancery Permits Parties to Seek Relief in Delaware Despite a New York Forum Selection Clause”

by: Francis G.X. Pileggi and Chauna A. Abner

Amidst the COVID-19 pandemic, the Delaware Court of Chancery recently held that despite a forum selection clause designating New York as the appropriate venue to litigate disputes arising under an agreement, the parties could seek relief in the Court of Chancery because New York courts were unavailable.  Conduent Bus. Servs., LLC v. Skyview Capital, LLC, C.A. No. 2020-0232-JTL, Transcript Ruling, at **33-34 (Del. Ch. Mar. 30, 2020).

In Conduent Business Services, the complaint asserted an anticipatory breach of an asset purchase agreement and sought a declaratory judgment interpreting the terms of the agreement. Id. at 10. That agreement had a forum selection clause designating New York as the forum to litigate disputes arising from the contract. Id. at *19. Before the Court was plaintiff’s motion for expedited proceedings.

The defendant argued that plaintiff’s claim for relief was not colorable because venue was not appropriate. Id. at *20. The defendant contended that the applicable law under the contract is New York law, and the Court should not impose “an exception to what remains New York law for which the parties bargained.” Id. at *18. The defendant argued that “part of the corpus of New York law right now is how the New York courts are handling commercial cases. And that includes, as both sides have briefed, that right now they are not handling this.” Id. at **17-18. Finally, the defendant noted that the New York courts provided for emergency applications and the plaintiff did not make that application. Id. at **18-19.

In response, the plaintiff urged that it was not “trying to stomp on the venue clause” and that it was “just trying to make sure that [it] can protect [it]sel[f] from irreparable harm while the New York courts are closed.” Id. at *32.

In ruling on whether venue was appropriate, Vice Chancellor Laster stated: “frankly, I think the fact that the New York Court is unavailable is pretty dispositive.” Id. *10. He explained that there is no dispute that “under normal circumstances, the forum selection clause in New York would be binding.” Id. at *33. Thus, he phrased the issue as “whether the circumstances, where New York — for understandable reasons given, the current crisis that the city is facing — has decided not to accept expedited commercial matters constitutes a situation that allows the parties to resort to other tribunals that are potentially capable of granting emergent or expedited relief.” Id.

In holding that venue was proper in the Court of Chancery to resolve the motion to expedite, the Court reasoned that “case law holds that where a forum selection clause specifies a forum that is unavailable, parties can resort to a different forum, where appropriate jurisdiction exists” and that case law applies here. Id. The Court explained that this ruling was not intended to disrespect the courts of New York, but it acknowledges that “[t]he reality is that [New York courts] face an extraordinary situation right now, and so it’s understandable that they’d be in a position where they can’t handle disputes.” Id. at **33-34.

Given the uncertain times that the COVID-19 pandemic has resulted in, including the unknown long-term effects, if any, that it will have on courts throughout the country, the Court’s ruling that “people can go to other courts, if the jurisdictional bases are met, and seek relief in those courts” is of paramount importance. Id. at *34. Although this is a transcript ruling, in Delaware, parties may cite transcript rulings in briefs as authority.

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 Chancery Court recently ruled that municipal bond powerhouse Nuveen LLC improperly used “lies” and “threats” in a successful campaign to damage the business of much smaller rival Preston Hollow Capital LLC but it declined to enjoin the alleged wrongs because Nuveen had discontinued them in Preston Hollow Capital LLC v. Nuveen LLC, et al. , No.2019-0169-SG memorandum opinion (Del. Ch. April 9, 2020). A prior Chancery decision in this case handed down last year, highlighted on these pages, addressed defamation claims, among other issues.

Vice Chancellor Sam Glasscock’s April 9 post-trial memorandum opinion found key Nuveen employees tortiously interfered with the Dallas-based PHC’s vital business relationships and opportunities with a half dozen major banks and bond broker-dealers by intentionally mispresenting PHC’s “predatory” investment practices and pushing them to drop PHC to keep Nuveen, self-serving and disingenuous

Both parties are Delaware-chartered finance companies that specialize in municipal bonds–debt securities issued by cities, counties, states and other governmental entities to finance public works projects–but while PHC had $1.3 billion in equity capital, Nuveen and two sister companies headquartered in Chicago had assets of $150 billion in its municipal bond division alone.

The players

The main players in the $3.82 trillion municipal securities market are issuers–the municipalities who sell the bonds, investors–including financing companies like the litigants, banks and smaller buyers, and broker-dealers that provide marketing, pricing and underwriting services.

The type of municipal bonds at issue in the litigation, private placements bought by one investor, are called “100% placements” and are more lucrative, carry a higher risk, require fast-paced communications with trusted broker-dealer connections and are highly competitive.

PHC’s relatively small but fast-growing share of such 100% placements caused Nuveen to see the company as a threat, prompting a series of written and oral warnings from Nuveen officials to brokers and banks that regularly participate in high-yield municipal bond offerings.

That in turn, motivated PHC to file a February 2019 Chancery Court suit claiming Nuveen tortiously interfered with its business relationships by maliciously launching a campaign to wreck its bond business, sabotaging its vital relations with banks and institutional investors, the opinion said.

Predatory practices?

Vice Chancellor Glasscock found evidence that several high-ranking Nuveen bond specialists warned Goldman Sachs, Deutsche Bank and J.P. Morgan units about “predatory” practices that they said PHC commonly employed and threatened to stop doing business with them unless they dropped PHC.

As to the tortious interference charge, the opinion said, first, PHC proved it had a reasonable probability of a business opportunity with those clients because it could demonstrate a “bona fide expectancy“ of opportunity since it could “identify a specific party who was prepared to enter into a business relationship but was dissuaded” by the defendant.

Concerning the second prong required to prove the tort, the vice chancellor found Nuveen intentionally interfered with PHC’s business expectations, despite Nuveen’s contention that it was merely targeting problematic 100% placements rather than PHC’s business in general and that Nuveen officials’ references to getting rid of “Preston Hollow” were just a “shortcut” for eliminating those deals.

Self-serving and disingenuous”

The court found that testimony “both self-serving and disingenuous” because it was clear that “Nuveen personnel meant what they said…Stop doing business with Preston Hollow or face the consequences,” including time in a type of virtual corporate penalty box and losing their business with Nuveen.

The vice chancellor prominently noted that Nuveen’s witnesses routinely employed numerous “circumlocutions for falsehoods” such as: “hedge,” “bluff,” “exaggeration,” “role-play,” “scenario,” “overstatement,”  blustering,” “short-cutting,” “puff,” “shorthand,” and “overblowing,” causing him to wonder whether the word “lie” was in their vocabulary.

He found that Nuveen’s interference caused PHC demonstrable harm because the defendant’s “lies” and “threats” pressured banks and brokers to change policies and behavior in a way that “curtailed the business expectancies of Preston Hollow.”

The court rejected Nuveen’s defense that its actions were shielded by the business competition exception because to excuse liability under Section 768 of the Second Restatement of Torts regarding the privilege to compete, the defendant must show: the matter in dispute involved the competition, the actor did not employ a wrongful means and did not create or continue an unlawful restraint of trade and the actor’s purpose was only to advance competition.

Since he found that Nuveen clearly employed a wrongful means–the second factor of the list, Vice Chancellor Glasscock said it was unnecessary to examine the rest because of Nuveen’s misrepresentation and economic pressure.

“Reckless indifference to the truth”

Nuveen’s statements to a half-dozen banks and brokers that it had evidence to support its allegations that PHC lied to issuers when It actually had only rumors “amounts to a reckless indifference to the truth” and its use of economic pressure to drive a competitor out of business constitutes wrongful means, the court said.

“I find that Nuveen was not simply attempting to achieve a competitive edge: it meant to use the leverage resulting from its size in the market to destroy Preston Hollow,” the vice chancellor wrote.

The court declined to consider PHC’s claim that Nuveen violated New York’s Donnelly CT OF 1899 (N.Y. Gen. Bus. Law §§ 340–47.) by allegedly organizing a boycott among broker-dealers (many of whom are based in New York).  He found it would be “an imprudent determination” of an unclear New York law.

No mea culpa, no money damages

As to the normally requested remedy in such cases–money damages–the vice chancellor noted PHC has not requested that here, although it has a related suit pending in the Delaware Superior Court for defamation—which must be heard by a jury and where damages are an available remedy.

He said he could not grant the injunction PHC seeks barring Nuveen from further wrongs and ordering it to issue a mea culpa apology letter disavowing its tortious behavior because Nuveen stopped the wrongs PHC sued over and clarified its statements, removing the necessary threat of irreparable harm.

The Delaware Court of Chancery recently granted, in part, a stockholder’s request, after a trial without live testimony, for corporate books and records pursuant to DGCL Section 220, in a matter styled Paraflon Investments Ltd. v. Linkable Networks, Inc., C.A. No. 2017-0611-JRS (Del. Ch. April 3, 2020).

Readers of these pages over the last 15 years will recognize a familiar pattern in the procedural history of this Section 220 case, as did the Court. See footnote 1 and accompanying text. The company typically resists the request for records, suit is filed, and after trial the Court (sometimes) grants the requests in whole or in part.

Many of the hundred-plus highlights on this blog of Section 220 decisions reflect the reality that Section 220 is not a precise tool.

This pithy decision provides a succinct overview of the pre-trial statutory prerequisites, for example, to comply with the form and manner aspects of a demand, and the elements of a statutory claim that need to be established at trial by a preponderance of the evidence.

This opinion also discusses several nuances of this type of statutory claim that have been developed via case law over the last few decades but are not obvious from a reading of the statute. This type of statutory analysis should be compared with a purely contract-based demand for books and records in the LLC context.

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 dismissed a shareholder’s derivative suit because he could not prove lululemon Athletica, Inc.’s directors breached their duty of loyalty by giving ex-CEO Laurent Potdevin $5 million to leave the athletic wear company instead of firing him for alleged misconduct in Shabbouel v. Potdevin, et al., No. 2018-0847-JRS memorandum opinion, (Del. Ch. April 2, 2020).

In its April 2 memorandum opinion, the Court ruled that plaintiff David Shabbouel’s allegations failed Delaware’s pre-suit demand test because the deferential business judgment rule gave the directors the latitude to settle with Potdevin to avoid a legal battle’s cost, risk and embarrassment.

Therefore, the vice chancellor concluded, Shabbouel is not excused from first demanding the lululemon board take up his charge that the directors disloyally used the resignation settlement to shield them from liability for ignoring Potdevin’s alleged sexual favoritism, harassment and creation of a “toxic culture”.

‘Inappropriate incidents’

The opinion says Potdevin abruptly resigned from the Delaware-chartered firm based in Vancouver in 2018 after the board investigated claims of two vaguely-described “inappropriate incidents” tied to his romantic involvement with a clothing designer who worked for him during his 2014-2017 tenure as CEO.

Shabbouel’s suit claimed the directors ignored “red flags” of “well-documented malfeasance” and instead of firing Potdevin for cause, the directors breached their fiduciary duties and wasted company assets by giving him a $5 million severance to leave quietly.

Plaintiff claimed it would have been futile for him to ask those directors to sue themselves for putting their own interests ahead of those of the company because of their conflict of interest.

High bar set higher

But the Court explained that the plaintiff had an even higher bar to clear than the usual pre-suit demand hurdle because lululemon had adopted an exculpatory clause in its charter that exempted the directors from any money liability for ordinary negligence, requiring Shabbouel to prove breach of loyalty or bad faith.

He fell “well short” of either mark, the opinion said, because the charges do not meet either of the prongs of the Delaware Supreme Court’s seminal Aronson v. Lewis opinion.  Aronson v. Lewis, 473 A.2d 805, 813–14 (Del. 1984)

That ruling requires that under Chancery Court Rule 23.1(b), when a derivative plaintiff decides to forego making a demand he must make particularized pleadings to support claims that the directors were interested in the deal or that the transaction was either not the product of a valid business judgment or that it was a waste of corporate assets.

Not a Caremark claim?

The Vice Chancellor observed that Shabbouel tried to satisfy that requirement by charging that the board “failed to implement adequate internal controls to ensure that lululemon’s activities complied with a all applicable laws,” which appeared to be one of the suit’s Caremark claims of inadequate oversight.  In re Caremark Int’l, Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996).

But according to the opinion, the plaintiff says he is not charging a failure of the directors’ duty of oversight that violate legal and regulatory compliance standards — which is the crux of the famous Caremark ruling.  Instead, he maintains he is charging the board breached its duty by using the CEO’s separation agreement to sweep its oversight failures under the carpet.

Can’t meet either Aronson

The Court found the suit does not satisfy either prong of the pre-suit demand requirement.  It doesn’t plead particularized facts that at least five of lululemon’s 10 directors: appeared on both sides of the agreement, derived a personal benefit from it, or were beholden to an interested person.

The Court reasoned that to properly plead this prong of Aronson, plaintiff would have had to show that the agreement “extinguished a substantial likelihood of board liability,” but Shabbouel admits that lululemon established an ethics code and a whistleblower hotline and used those systems to detect misconduct.

Moreover, the Court noted, there were no allegations that once they discovered the inappropriate behavior, the directors acted in bad faith by ignoring it or significantly delaying its response; instead they hired independent counsel to investigate, reviewed counsel’s report, appointed a director to negotiate with Potdevin and secured his quiet departure.

That is far from a “conscious indifference to red flags” that might generate liability exposure – especially since the company’s exculpatory charter provision requires that the challenged decision “must be so egregious on its face that board approval cannot meet the test of business judgment,” the opinion says.

Benefits cancel waste claim

The settlement was not a waste of assets because it secured the CEO’s release of all claims against lululemon, liberated the firm from his troublesome tenure, swiftly remediated an allegedly “toxic” culture and avoided a potentially costly and embarrassing lawsuit, the vice chancellor said.

The Court ruled that the directors had to make a quick fire-or-settle choice and it was “the board’s prerogative to decide when it had enough information to decide how to separate Potdevin from the company — not plaintiff’s.”

The Court acknowledged that there is an “outer limit” at which such a separation pact would be unconscionable and constitute waste but this agreement did not come close to that limit for pre-suit demand purposes, so “there is nothing wrong with your television set”, he said, referring to a 1960’s science fiction TV series famous for plot twist endings.