Andrew J. Czerkawski of the Lewis Brisbois Delaware office prepared this post.

          Minority shareholders of a former publicly traded telecommunications company brought suit in the Delaware Court of Chancery, alleging the controlling shareholder, with the aiding and abetting of the company’s pre-spin-off parent, breached his fiduciary duty of loyalty he owed to the minority.  The lead plaintiff claimed the controller caused the company to unfairly sell a litigation asset in In re Straight Path Communications Inc. Consolidated Stockholder Litigation, 2023 Del. Ch. LEXIS 387 (Del. Ch. Oct. 3, 2023).

BRIEF FACTUAL OVERVIEW

          The prior parent spun off a patent infringement portfolio to insulate itself from potential counterclaims and transferred various IP assets, including a portfolio of broadcast spectrum licenses.  As part of the separation agreement’s stock swap ratio, the prior parent’s founder and chairman became the new company’s controller.

          As a result of a regulatory investigation concerning broadcast spectrum licenses, the company entered into a multi-million dollar settlement with the regulator, consisting of fines and other penalties.  Under the spin-off separation agreement, the company could seek indemnification for those penalties from the parent.  The company’s board considered this indemnification claim a valuable company asset.  The company formed a fully independent special committee to handle the sale of the company’s IP assets and pursue the indemnification claim.  But, as detailed below, the controller usurped the process and used his positional influence to cause an unfair settlement of the claim.

KEY ANALYSIS

          As a threshold matter, the Court determined that the defendant parent’s founder and chairman controlled more than seventy percent of the spun-off company’s voting power.  Similarly, because of the parent’s flagship status and through his familial ownership ties, the company’s release of the indemnification claim against the parent conferred a non-ratable benefit to the controller.  Thus, entire fairness review of the indemnification claim release applied.

          The Court employed the unified entire fairness test, considering the fairness of both the price and the process.  Though it discussed at length the viability of the indemnification claim as a company asset, due to the company’s failure to comply with the separation agreement’s notice and consent requirements, the Court found the indemnification claim “had no economic value.”  Thus, because the parent paid the company $10 million to release an essentially worthless claim, the parent paid a “not unfair” price.

          Yet, the decision highlighted the controller’s “steamrolling” tactics and the “overwhelming evidence of unfair process.”  Reiterating the process factors (timing, initiation, structure, negotiation, disclosures, approval), the Court wrote: “This court is frequently asked to make findings of controller overreach based on only circumstantial evidence, cryptic communications, or inference.  This is not one of those cases.”  The controller “made every effort to bully the Special Committee towards his desired outcome.”

          The Court observed the controller’s “campaign of abuse and coercion.”

          Emphasizing the unified analysis, finding a fair price paid did not end the Court’s decision: “the question is one of entire fairness, and what the stockholders could have achieved, absent the iniquities.”  The Court pointed out its precedent on fair process—“[t]his court has held that a fair price ‘does not ameliorate a process that was beyond unfair.”  The defending fiduciary must satisfy “[b]oth aspects of the entire fairness test – fair dealing and fair price.”  “This assessment provides an opportunity to evaluate the transaction holistically and ‘eliminate the ability of the defendants to profit from their breaches of the duty of loyalty.’”

          Noting that a claim for breach of fiduciary duty does not require the plaintiff shareholder to prove actual damages, the Court found the controller’s “coercion” of the special committee “breached his duty of loyalty to the minority stockholders” and held the controller liable for nominal damages.

PRACTICAL TAKEAWAY

          In disputes challenging the fairness of conflicted controller transactions, fiduciary liability does not live and die on price alone.  Even if the controller forces an otherwise sweetheart deal, the court will still closely scrutinize the manner in which the controller exercised that force.  If the transaction’s process tips the deal’s unfairness past equipoise, then the controller faces nominal damages along with a judicial rebuke.

Andrew J. Czerkawski of the Lewis Brisbois Delaware office prepared this post.

The sponsor of a busted de-SPAC merger asked the Delaware Court of Chancery to order the target to close under the merger agreement’s reasonable best efforts clause, but the Court refused to do so in 26 Capital Acquisition Corp. v. Tiger Resort Asia Ltd., 2023 Del. Ch. LEXIS 364 (Del. Ch. Sep. 7, 2023).

BRIEF FACTUAL BACKGROUND

          A Japanese gaming company parent, through its intervening subsidiary, owned a valuable casino in the Philippines.  A New York-based hedge fund purchased and held a small block in the parent.  After the parent failed to launch an IPO, the fund proposed a de-SPAC merger transaction to the parent’s investor relations manager.  Receptive to the idea, the parent engaged the fund in a formal advisory relationship, in which the fund would facilitate and analyze any potential SPAC deal.

          The fund connected with a potential sponsor and pitched the idea.  But before making introductions, the fund demanded and eventually procured a majority economic interest in the sponsor.  In a series of events too lengthy and nuanced to detail here, the fund worked as a “double agent”—convincing the parent with whom the fund had a formal advisory relationship to accept the deal while feeding inside information back to the sponsor in order to make it happen.

          Meanwhile, an ousted former director of the parent challenged his removal in the Philippines and received a favorable ruling.  The Philippine Supreme Court subsequently issued a status quo ante order.  Though the parties could not decisively determine whether consummating the deal would violate the order, the fund nevertheless continued to push the closing.  The target’s management began to suspect the fund’s deception, which the fund denied.

          A month after receiving the status quo order, the ousted director, with the help of the local police, enacted a violent physical takeover of the casino in the Philippines.  Still, the sponsor and the fund “seemed not to care about the fate of the employees and remained laser focused on closing the transaction.”  After the parent failed to retake the casino via judicial process in the Philippines, a politically oriented “dodgy bargain” occurred.  The Philippine executive branch then stepped in and “declared the takeover illegal,” helping the parent regain control.

          After more clandestine scheming with the fund, frustrated with further extension of the merger, the sponsor filed suit in the Delaware Court of Chancery, seeking to force the target to close.

KEY ANALYSIS

          Delaware law, though “strongly contractarian,” does not categorically require the Court to enforce a reasonable best efforts clause through an order of specific performance.  Rather, granting “[s]pecific performance is a matter of grace that rests in the sound discretion of the court.”  Examining multiple factors, the Court determined that the circumstances disfavored the “extraordinary” remedy of specific performance.

          First, the transaction’s complexity and “associated difficulty of providing meaningful judicial oversight” weighed against ordering the target to close.  The interim steps remaining before closing and the quagmire of factual circumstances counseled against specific performance: preparing audited financial statements; filing a securities registration statement; dealing with the SEC; a foreign gambling corporation; a history of poor internal governance; a physical takeover; likely corrupt political ties; and “exceedingly aggressive” counterparties with “terrible judgment.”

          Second, the operative parties and their assets’ overseas locations, outside the Court’s reach to enforce coercive sanctions, rendered any order compelling the target to close a “nullity.”  The Court opined, “the sun has set on the era in which a nation might send gunboats to enforce a judgment issued by its courts,” also emphasizing that  “Delaware has no blue water navy to send, and the United States Constitution confers authority over international affairs on the federal government, not the several states.”  Acknowledging its own enforcement limitations, the Court further opined, “[t]he court is not dealing with an obstreperous billionaire or other headstrong individual whose body and assets are subject to coercive sanction through the American justice system.  In this case, the defendants are, quite literally, outside the range of the court’s armamentarium.  Firing at such a target just wastes ammunition.”

          Third, the foreign status quo order weighed against ordering the target to close.  If the target did so, it risked violating the foreign high court order, potentially subjecting it to criminal contempt.  Thus, such a consequence counseled against specific performance even under the merger agreement’s reasonable best efforts clause.

          Fourth, the Court considered and thoroughly laid out the sponsor acquiror and its hedge fund majority shareholder’s inequitable conduct.  With no sugar coating, the Court bullet-pointed their duplicitous actions and emphasized that they “acted as partners to gain and exploit their inequitable advantage over” and “engaged in a conspiracy to mislead” the target and its subsidiaries, “the type of conduct that should not be rewarded with a decree of specific performance.”

          Finally, balancing the equities, the Court considered the interests of the acquiror’s unaffiliated shareholders.  But the Court nevertheless determined that its shareholders “cannot truly claim the status of innocent victims.”  Noting that the acquiror’s shareholders “backed” the wrongdoing and “signed up for the ride,” undertaking to “benefit from the gains or suffer the losses that [the sponsor] and his team delivered,” the Court refused to allow the sponsor to “wrap itself in the mantle of its stockholders to pretend that none of the events described in this case ever happened.”  The sponsor and its hedge fund majority stakeholder tried to persuade the Court that “they were justified in doing outrageous things because they were obligated to serve their stockholders.”  But the Court refused to lend this logic any credence: “[t]hat assertion is a perversion of the fiduciary regime.  Fiduciary duties exist to check management misbehavior.  They are not a license for management to misbehave.”

PRACTICAL TAKEAWAYS

          This decision highlights the extraordinary nature of specific performance as an equitable remedy and the potential factors and circumstances the Court will consider when deciding whether to award it.  Plaintiff acquirors seeking to compel their targets to close highly complex deals involving foreign parties and foreign assets face an uphill battle.

          But, perhaps more importantly, this decision serves as a warning to conflicted financial advisors, deal advocates, and fiduciaries alike, that the Court will not condone surreptitious, conflicted tactics masquerading as serving the shareholders.  The Court will look to the plaintiffs hands and apply the maxim: “he who seeks equity must do equity.”

Rolando Diaz of the Lewis Brisbois Delaware office prepared this post.

          The Court of Chancery refused to enforce a restrictive covenant in Sunder Energy, LLC v. Jackson, 2023 Del. Ch. LEXIS 580 (Del. Ch. Nov. 22, 2023). Chancery subsequently approved, with thorough reasoning, an interlocutory appeal to the Supreme Court–which makes its own determination whether to accept the interlocutory appeal.

BRIEF FACTUAL BACKGROUND

          Sunder Energy, LLC (“Sunder”), a Delaware LLC headquartered in the State of Utah, a purveyor of residential solar power systems, had an exclusive dealer agreement with Freedom Forever LLC (“Freedom”), one of the nation’s largest installers. In the summer of 2023, Freedom encouraged Tyler Jackson, the head of sales for Sunder, who lived and worked in the State of Texas, to join Solar Pros LLC (“Solar Pros”), another solar power system dealer that referred installations to Freedom.  This led to a mass exodus of Sunder’s workforce. Nine of the twelve regional managers that reported to Jackson, as well as over three hundred sales personnel, joined Solar Pros.  On September 25, 2023, Solar Pros announced that Jackson had joined as its new President.

          Sunder asserted that Jackson—as a holder of Incentive Units—was bound by certain restrictive covenants (the “Covenants”) provided for in Sunder’s 2019 and 2021 LLC operating agreements (the “OA”) that applied to any Incentive Unit holder (the “Holder”).  The co-founders formed Sunder by filing a certificate of formation with the Delaware Secretary of State but did not execute a written operating agreement. 

In the fall of 2019, the two co-founders that together owned 60% of the membership interest of Sunder engaged a law firm to draft an LLC agreement that dramatically changed the ownership structure of the LLC; it imposed the Covenants, emasculated the minority members rights as owners, and reduced them to purely economic beneficiaries with very little rights. Communications from the majority co-founders to the minority rights holders did not explain that the two co-founders received common units with full rights while the minority holders received incentive units with little to no ownership rights. 

In a concerted effort to obfuscate reality, the majority co-founders referred to the Holders as “partners,” implying that there was some semblance of equal footing aside from the difference in percentage of interests. For the subsequent adoption of the 2021 operating agreement, the majority co-founders did not even bother to circulate a copy of the new operating agreement.  Instead they only circulated the signature page and indicated to the Holders that there were no substantive changes to the operating agreement and that the only change was the addition of a member.  This was not true.  The geographical scope of the restrictive covenant was also expanded.

          In addition to broad restriction on the use of Sunder’s confidential information, the Covenants in the OA prohibited a Holder from: (i) engaging in any competitive activity (the “Non-Compete”); (ii) soliciting Sunder’s employees and independent contractors (the “Worker Non-Solicit”); (iii) soliciting, selling to, accepting any business from, or engaging in any business relationship with any of Sunder’s customers; and (iv) inducing, influencing, advising, or encouraging any Sunder stakeholder to terminate its relationship with Sunder. Furthermore, each Covenant bound not only the Holder, but also Holder’s affiliates, defined in the OA as a Holder’s spouse, parents, siblings, and descendants, both natural and adopted. The Covenants applied while a person held incentive units and for two years thereafter.  However, a Holder had no right to transfer or divest themselves of the Incentive Units. In contrast, Sunder had the option, but not the obligation, to repurchase the Incentive Units for zero dollars upon either Sunder’s termination of Holder’s employment or if the Holder left the company without good reason.

          On September 29, 2023, Sunder terminated the dealer-installation agreement with Freedom and filed an arbitration to enforce their rights against Freedom. Sunder also filed an action in the Court of Chancery against Jackson and its competitors. Sunder sought a preliminary injunction enjoining Jackson and any party acting in concert with Jackson from taking any action in breach of the Covenants. The Court denied the preliminary injunction because Sunder could not establish a reasonable likelihood of success on the merits.  The Court found (i) the restrictive covenants unenforceable under general principles of law and (ii) the competition and solicitation restrictive covenants unreasonable in their scope and effect.

KEY ANALYSIS

          First, the Court was faced with determining the Covenants’ governing law. The terms of the Covenants appeared in the OA, which governs the internal affairs of a Delaware LLC.  The OA expressly provided that Delaware law governed its terms.  Thus, a contractarian basis for the application of Delaware law existed. Under normal circumstances, the combination of the internal affairs doctrine and contract principles would require the application of Delaware law. However, for the Covenants, the drafters were not attempting to govern the internal affairs of a Delaware LLC.  Instead, the drafters were attempting to govern an employment relationship.  The Court opined:

Delaware follows the Restatement (Second) of Conflict of Laws, and Delaware courts consequently will not enforce choice of law provisions when doing so would circumvent the public policy of another state that has a greater interest in the subject matter. Consequently, when a different state’s law would govern in the absence of a choice of law provision, and if that state has established legal rules reflecting a different policy toward restrictive covenants, than Delaware’s then this court will defer to that state’s laws notwithstanding the presence of a Delaware choice of law provision.

Thus, either Utah, where Sunder is headquartered, or Texas, where Jackson worked and resided would apply in the absence of a choice of a law provision.  Under the Court’s analysis, both Texas and Utah approach the enforceability of restrictive covenants only slightly differently than Delaware. Under its conflict of laws analysis, due to the low degree of divergence between laws of the relevant forums, the Court applied Delaware law, finding that the conflict between Delaware and Utah law was a false conflict.

          Second, due to the circumstances for ratification of Sunder’s 2019 and 2021 LLC operating agreements, the Court determined that Sunder’s purported majority co-founders breached their fiduciary duty by failing to fully disclose all material information and making misleading partial disclosures to the minority.  The 2019 agreement materially and adversely impacted the rights of Sunder’s minority members; legal counsel only represented Sunder and the majority co-founders, but the co-founders made it seem as if counsel represented everyone. For the 2021 agreement, the co-founders told the minority members that the 2021 agreement contained no material changes and did not even bother to circulate a copy of the 2021 agreement to the minority members. Thus, the Court determined that due to the co-founders’ breach of fiduciary duties, the amended operating agreements themselves were invalid, and consequently, so were the restrictive covenants therein.

          Assuming, however, for the “sake of argument” that the amended LLC agreements were valid, the Court addressed the enforceability of two of the Covenants, namely, the Non-Compete and Worker Non-Solicit provisions. The Court found the Non-Compete provision extremely overbroad. The prohibited business activity covered a wide swath of the “door to door sales industry, without regard to whether Sunder markets or sells similar products.” The restriction on a Holder’s affiliates (as defined in the OA) was inane; it was not written in a manner that simply thwarts a straw man conferring the benefits to a Holder.  But, as written, a Holder’s “daughter cannot go door to door selling girl scout cookies.” Absurdly, the Covenants thus purported to bind a Holder’s wife and children. The geographic scope of the Non-Compete left only Alaska, Montana, North Dakota, and South Dakota available for a Holder as territory not restricted by the Covenants. Perhaps the most appalling factor of the Non-Compete was that since a Holder had no right to divest himself of the Incentive Units under the OA, the temporal component could continue in perpetuity. Similarly, the Court found the Worker Non-Solicit overbroad and unreasonable. It also applied to the same set of affiliates and for the same potentially “forever” time period. It extended not only to any current Sunder employee or independent contractor, but also applied to “any person employed in the past by Sunder for any period of time.” Individually, each overbroad provision was unreasonable.  And read together, the Court deemed the Covenants oppressive and refused to enforce them.

PRACTICAL TAKEAWAYS

          Delaware courts will not apply Delaware law under a theory of contract law if another state has a greater public policy interest in an issue when, absent a choice of law provision, another forum’s laws would apply. Circumstances may also dictate abandonment of the internal affairs doctrine when drafters embed employment provisions that have nothing to do with the governance of the entity into a governing agreement. Additionally, Delaware courts apply both general principles of law and a holistic analysis of restrictive covenants to determine reasonableness. This analysis can result in Delaware courts refusing to enforce restrictive covenants.

In a recent letter ruling, the Delaware Court of Chancery provided a short tutorial on the Chancery rules of procedure that describe the specific requirements for responding to discovery and the detail that the parties are obligated to provide, especially for objections. See Bocock, et al. v. Innovate Corp., et al., C.A. No. 2021-0224-PAF (Del. Ch. Dec. 6, 2023). 

For example, objections must be specific and must identify what is being withheld based on the objections. See Ct. Ch. R. 33(b)(4) (regarding interrogatories). See also Ct. Ch. R. 34 (regarding responses to requests for documents).

Highlights

  • Relying on prior Chancery decisions, the court instructed that “generic and formulaic objections are insufficient.” Slip op. at 8. 
  • The court also reminded us: that failure to assert a proper, timely objection in compliance with the rules risks waiver of objections. See Ct. Ch. R. 33(b)(4).
  • Specifically, the court referred to prior decisions that explain: “Boilerplate objections have been considered prima facie evidence of a Rule 26 violation, which causes the objecting party to waive any legitimate objections that they may or may not have had.”  Slip op. at 8-9.
  • The court instructed that “an objection must state whether the responding party is withholding or intends to withhold any responsive materials on the basis of that objection.”  Quoting Ct. Ch. R. 34(b).
  • The decision provides more examples of the failure to provide specificity or to explain the basis on which documents were being withheld. 
  • The court also emphasized why the failure to comply in this case justified waiver of all of the objections except for attorney/client privilege and work product doctrine.

Takeaway:

The Delaware Court of Chancery has emphasized the importance of specific, timely objections. Generic or formulaic objections are considered insufficient, potentially leading to waiver of objections. Failure to comply can result in waiving all objections.

Delaware Court of Chancery Rule 5.1 provides the standard and an intricate series of procedures for the parties to seek “confidential treatment” to prevent pleadings filed with the court from being publicly available. The prior version of the rule referred to this procedures as “filing under seal.”  Notably, analogous procedures in federal court employ a much different standard.

A recent pair of Orders from the Delaware Court of Chancery featured the unusual shifting of fees in connection with Rule 5.1, as an exception to the American Rule where each party pays its own fees. See Robert Garfield v. Getaround, Inc., C.A. No. 2023-0445-MTZ, Order (Del. Ch. Oct. 26, 2023). This is the first of two Orders that need to be read together to put them in context. The second Order is noted below.

The Orders understandably do not feature the typically copious background facts provided in opinions, but it includes sufficient information to make the point for purposes of this short blog post.

The noteworthiness of the Orders is that they will remind counsel that under Rule 5.1, when a party disagrees about what portions of a pleading should be designated as confidential, the party harboring the disagreement does not have the right to publicize the information sought to be kept confidential—until the court rules on the issue or unless the procedures provided in Rule 5.1 are followed.

With that background, the relatively short Order deserves to be quoted verbatim: 

“It was not for Plaintiff to unilaterally decide that information Defendant has designated and redacted as confidential in its opposition could be publicized in Plaintiff’s reply.  Defendant bore the burden of designation under Court of Chancery Rule 5.1(b)(3).  Nor was it for Plaintiff to resists Defendant’s call to withdraw Plaintiff’s Reply to publicize information Defendant had designated.  Rather, Plaintiff’s recourse was to file a Motion of Challenge to the Opposition and the Reply under Court of Chancery Rule 5.1(f).

The parties shall work with the Register in Chancery to place Plaintiff’s Reply under seal.  The parties shall follow Rule 5.1’s procedures to address any remaining disagreements as to whether information in that reply was fairly designated as confidential.”

The first Order was in response to a Motion by the Defendant to place under seal the Reply of the Plaintiff in opposition to the Defendant’s Motion to File Under Seal because that Reply was wrongly filed in a publicly available manner.

In a second Order shifting fees under the bad-faith exception to the American Rule, the Court reasoned that the Plaintiff’s:

“insistence on publicizing information Defendant designated as confidential serves no plain purpose other than agitation.  I conclude the publication in the opposition to the motion to seal was in bad faith. Fees are shifted for the Motion to Seal the Opposition.”

Garfield v. Getaround, Inc., C.A. No. 2023-0445-MTZ, Order (Del. Ch. Oct. 27, 2023)

Frank Reynolds, who has been covering Delaware corporate decisions for various national publications for over 35 years, prepared this article.

The Delaware Court of Chancery, in a key ruling on the third-party beneficiary rights of merger target shareholders, has dismissed an ex-Twitter Inc. investor’s “lost premium” suit that sought a $3 million “mootness fee” after Elon Musk reversed his decision to abandon the social media giant’s purchase in Crispo v. Musk, et al., No. 2022-0666-KSJM (Del. Ch. Oct. 31, 2023).

Chancellor Kathaleen St. Jude McCormick’s October 31 opinion found plaintiff shareholder Luigi Crispo’s suit was not meritorious when filed since he never had a valid claim that he should profit by Musk’s buy decision. She said either he lacked third-party status or those rights had not yet vested during Musk’s on-again-off-again acquisition.  But she took the occasion to comprehensively clarify the parameters of third-party shareholder beneficiary rights—which might benefit M&A practitioners.

The Chancellor noted that although the facts of this case made the decision seem deceptively simple, the complexity of the underlying rights issue has the potential to form a legal “Gordian KnoI” which requires some explanation as to how it might be cut.

Background

The litigation arose out of Elon Musk’s July 2022 decision to acquire Twitter—and his change of mind less than three months later to scrub it, resulting in a suit by Twitter for specific performance, but Musk changed his mind again in October and consummated the deal on the original terms that month.  Meanwhile Crispo, who held 5,000 shares of Twitter, sued Musk and his X Holdings Inc. I and II  acquisition companies in July for breach of the merger pact and breach of duty as the controller of Twitter,

After Chancellor McCormick dismissed most of those claims and the sale closed, Crispo’s suit was considered dead, but it “sprang back to life zombie-like” she said, when Crispo claimed partial credit for Musk’s. change-of-heart and sought a $3 million award on grounds that Musk mooted plaintiff’s breach of merger charge by keeping his deal promise after all.

Meritorious mootness suit?

Chancellor McCormick said the Delaware Supreme Court has held that mootness fees are only awarded when:

i)The suit was meritorious when filed

ii) the action that produced the benefit to the corporation “was taken by the defendant before a judicial resolution was achieved;” and

iii) “the resulting corporate benefit was causally related to the lawsuit.”

“In order for a suit to be considered meritorious when filed, the complaint must have been able to have survived a motion to dismiss, whether or not such a motion was filed,” so he must prove the remaining lost premium claim was meritorious for the suit to survive, the Chancellor pointed out; but she added that plaintiff  was not a party to the Merger Agreement, so the merits of his claim hinge on the argument that he had standing to sue for breach of the agreement as a third-party beneficiary

To allege standing as a third-party beneficiary, a plaintiff must plead that:

i) “the contracting parties . . . intended that the third party beneficiary benefit from the contract,”

ii) the benefit [was] intended as a gift or in satisfaction of a pre-existing obligation to that person, and

iii) “the intent to benefit the third party [was] a material part of the parties’ purpose in entering into the contract.”

Was the investor vested?

But the Chancellor ruled that, “[T]hird party beneficiaries, however, cannot object to the alteration or termination  of the contract before their rights against the promisor have vested.’’  and Crispo’s rights had not vested.

Moreover, she said, Delaware courts are reticent to confer third party beneficiary status to stockholders under corporate contracts for a mix of doctrinal, practical and policy reasons not the least of which is that “under Delaware law, the board of directors manages the business and affairs of the corporation, which extends to litigation assets.”  That includes Delaware’s exacting presuit demand test for shareholders who seek to sue on behalf of the corporation.

Lost Premium Provision no help

The court said Section 9.7 of the Merger Agreement is a no-third-party-beneficiaries provision which comprises a blanket prohibition disclaiming third-party beneficiaries followed by three. carve-outs but none of those provide any help for the plaintive here.  In addition, the chancellor noted, the blanket prohibition states that the Merger Agreement “shall not confer upon any Person other than the parties hereto any rights or remedies hereunder[.]”

Conclusion

Finally, she said, the parties stipulated to specific performance as to “prevent” breaches of the Merger Agreement, suggesting that a breach claim seeking lost-premium damages would not accrue unless specific performance was unavailable.  The limitation necessarily implied by the Merger Agreement is that the drafters did not intend to vest stockholders with a right to enforce lost-premium damages while the company pursues a claim for specific performance, she concluded.

This post was prepared by Andrew J. Czerkawski, an associate in the Delaware office of Lewis Brisbois, who is scheduled to be sworn in to the Delaware Bar in December 2023


          In Hoffman v. First Wave Biopharma, Inc., 2023 Del. Ch. LEXIS 378 (Del. Ch. Sep. 27, 2023), the Delaware Court of Chancery determined that board actions did not trigger a fellow director’s mandatory advancement right.

Background

          Hoffman served on the board of directors of First Wave Biopharma, Inc. (the “Company”). After a soured acquisition, the target’s stockholder representative sued the Company.  The resulting settlement discussions contemplated the Company paying the stockholder representative $1.5 million.

          During the relevant period, the Company’s board discussed and decided to raise an additional $4 million, not planning to tell the public for some months. Yet, a former stockholder nevertheless learned of the planned equity raise and leveraged that information to increase the settlement amount with the stockholder representative by another $1 million.

          The Company’s board concluded that Hoffman, the Plaintiff, leaked the information.  Though the board “had no concrete evidence,” the board drew this conclusion because (i) the planned equity raise remained non-public information and (ii) only Hoffman “had a positive relationship” with the former stockholder.  In turn, and out of fear of further leaks, the board established a committee comprising all the directors except Hoffman.

          Disagreeing with his exclusion, Hoffman retained counsel and exchanged a series of correspondence with the Company, including a Section 220 demand, ultimately resulting in an indemnification and advancement request.  Though it produced responsive book and records, the Company claimed the Plaintiff breached his fiduciary duties and denied any indemnification or advancement.  The captioned litigation ensued.

Arguments

          Neither party disputed that the Plaintiff’s director status afforded him certain mandatory advancement rights under a separate indemnification agreement with the Company.  But only defined “covered proceedings” triggered that right. The issue was whether an “investigation” and an “inquiry” was conducted in order to trigger a covered proceeding.

          The Plaintiff contended that because the Company concluded he leaked the non-public information and therefore breached his fiduciary duty, “the [Company] necessarily must have conducted an ‘investigation’ and/or ‘inquiry’ into [the Plaintiff’s] actions.”  Thus, the Plaintiff contended, because the Company conducted either an investigation and/or inquiry, the Company triggered the Plaintiff’s mandatory advancement right. The Company contended “it never undertook an investigation or inquiry into [the Plaintiff’s] conduct.”

Court’s Analysis and Findings

          The Court determined that the board took no steps to confirm the belief that the Plaintiff leaked the information and found that “the Company did not investigate or otherwise conduct an inquiry into [the Plaintiff].”  The Court ultimately held that because “the Company directors started from the conclusion that [the Plaintiff] leaked” the non-public information, the Company’s actions were “corrective actions from that conclusion, not investigative actions undertaken in reaching that conclusion.”  Thus, because the Company only took “remedial, not investigatory” actions to assuage their fear of further leaks, the board’s response fell “short of an ‘investigation’ or ‘inquiry’ sufficient to trigger [the Plaintiff’s] advancement rights.”

          The Court, as it often does, turned to dictionary definitions in order to ascertain the plain meaning of the words “investigation” and “inquiry.”  Relying on these definitions, the Court denied the Plaintiff mandatory advancement, holding: these definitions require “more positive action, pomp, and procedure than one individual’s immediate deductive conclusion based on known facts.”

Takeaway

       The Plaintiff might have succeeded in procuring advancement from the Company if the language setting forth the events triggering his advancement right included broader categories.  For instance, if the clause included “conclusion, accusation, or contention of the Company,” then the board’s actions, though falling short of “investigation” or “inquiry,” would nevertheless still likely rise to the level of a “conclusion, accusation, or inquiry” sufficient to trigger the mandatory advancement right. 

This post was prepared by Andrew J. Czerkawski, an associate in the Delaware office of Lewis Brisbois, who is scheduled to be sworn in to the Delaware Bar in December 2023.

In Tilton v. Stila Styles, LLC, 2023 Del. Super. LEXIS 772 (Del. Super. Ct. Sep. 19, 2023), the Delaware Superior Court found an advancement claim unripe.

Tilton served as the sole manager of Stila Styles, LLC, a single-member Delaware LLC (the “Company”).  When the Company’s sole member removed her as manager, the Plaintiff challenged her removal in the Court of Chancery, lost, appealed, and lost again.

Tilton, the Plaintiff, sent the Company completely redacted legal fee invoices.  The Company in turn requested unredacted copies. The Plaintiff sent back partially redacted copies but on the same day filed a complaint against the Company seeking in the Superior Court, inter alia, her outstanding fees and expenses the Company did not advance pending the appeal of the Court of Chancery suit.

The Court determined that the Plaintiff “prematurely” sought a judgment on the pleadings and brought an “unripe” advancement claim.  In doing so, the Court admonished: “Rather than provide [the Company’s] counsel with an opportunity to determine the reasonableness of [the Plaintiff’s] advancement requests, [the Plaintiff] precipitously sought court intervention.”  The Court further advised: “[t]hese are the exact sort of litigation tactics that unnecessarily burden the Court and vitiate what would otherwise be a good faith petition for judicial relief.”

 Finding the advancement claim “unripe,” the Court instructed that “[the Plaintiff’s] counsel frustrated any viable process to resolve the advancement requests in good faith by providing partially redacted invoices the same day that they filed the instant action, seeking payment of those entries.”  The Court ordered the parties to meet and confer on the advancement claim because “[w]hether the entries themselves are reasonable or not is a factual dispute, and until the parties meet and confer on a good faith basis to resolve the advancement demands, moving for judgment on the pleadings is not ripe, and hence, improper.”

Takeaways: First, before filing a complaint, the party seeking advancement should provide the board with invoices redacted only as necessary to preserve any privilege.  Second, the party seeking advancement should wait until the board responds, or, if the board returns no timely response, the party seeking advancement should wait a reasonable amount of time in which a board could otherwise respond. 

Former U.S. Attorney General William Barr wrote an article in today’s Wall Street Journal arguing: Delaware is at risk of losing its prominence in corporate law because of what the former U.S. Attorney General describes as the increasing infiltration into Delaware corporate law of ESG priorities, for example via Caremark claims.

Barr describes ESG as a means to inject left-leaning policy preferences into the law. It’s not a law review article, although he refers in passing to several developments that those familiar with Delaware corporate law will recognize. Whether he is correct or not in his admonition is currently a topic of debate among various sectors in the legal profession.

UPDATE: Professor Stephen Bainbridge, one of Delaware’s favorite corporate law scholars, has written an erudite response to AG Barr’s article, with copious citations and quotes from the good professor’s own extensive scholarship on the topic, as well as the publications of other leading authorities. Among the quotes in his article linked above, is one from a former Chancellor and Delaware Supreme Court Chief Justice, described as “pro-ESG”, which follows: “It is not only hollow but also injurious to social welfare to declare that directors can and should do the right thing by promoting interests other than stockholder interests.”

SECOND UPDATE: The Chancellor of the Delaware Court of Chancery, as reported in an article by Reuters, responded during a seminar to the referenced article by AG Barr, and Vice Chancellor Travis Laster also provided a rebuttal on LinkedIn, and invited AG Barr to a debate, as described in follow-up commentary by Professor Bainbridge–which includes, as usual, copious citations to his own extensive scholarship and the publications of other corporate law scholars.

The Delaware Court of Chancery recently addressed a litany of claims that the buyer of a business breached its contractual and fiduciary duties by diverting new deals that deprived the sellers from reaching milestones in the purchaser’s new entity that would have triggered increased value. 

In MALT Family Trust v. 777 Partners LLC, C.A. No. 2022-0652-MTZ (Del. Ch. Nov. 13, 2023), the court addressed a long list of claims that provide corporate litigators with a refresher course on basic claims and defenses often encountered in Delaware’s court of equity in connection with the sale of a business.

This short blog post will provide highlights by way of bullet points.

Highlights

  • The court recited the familiar elements of a claim for fraudulent inducement, as well as the specificity requirement of Rule 9(b) for fraud claims. See Slip op. at 10.
  • The court reviewed the well-settled Delaware law on the objective theory of contract interpretation.  See Slip op. at 15.
  • The court explained that the LLC agreement did not include any of the alleged express representations or warranties on which the Plaintiff’s allegations were based. Nor was the purpose clause a “representation or warranty.” See also the court’s application of the contract interpretation principle known by the Latin phrase: expressio unius est exclusio alteris. See Slip op. at 17.
  • The court observed that an LLC agreement is not required to have a “purpose clause,” but that if a purpose clause limits the scope of authorized activity of the LLC, only the company can breach that clause. In this matter, the allegations were against the individual members.  Slip op. at 17-20.
  • Court of Chancery Rule 8 allows duplicative claims in the alternative to be pled, but a nuanced approach applies when the breach of the implied covenant of good faith and fair dealing is contradicted by the expressed terms in an agreement.  Slip op. at 22-25.
  • The well-settled principle that fiduciary duties of an LLC manager and controllers of the LLC must be waived with specific clarity supported the court’s reasoning that the corporate opportunity doctrine was not waived.  Slip op. at 27-31.
  • This opinion regales the reader with a quote and citation to a reference book that should be on the shelves of every corporate and commercial litigator.  At footnote 101 of the opinion, the court cited to Justice Antonin Scalia’s book that he co-authored with Bryan Garner entitled:  Reading Law: The Interpretation of Legal Texts 126-27 (2012). In that same footnote the court also cited to Kenneth A. Adams, “A Manual of Style for Contract Drafting,” Section 13.631 (Fifth Ed. 2023). The citations were for the purpose of interpreting a clause that included the word “Notwithstanding.”  The specific quote from the Scalia book was: 

“A dependent phrase the begins with notwithstanding indicates that the main clause that it introduces or follows derogates from the provision to which it refers.” 

The court interpreted that clause in a section involving fiduciary duties to conclude that the parties did not intend to waive fiduciary duties relating to the usurpation of “other business interests and activities.”