Over the last 14 years that I have published this blog, I have compiled an annual review with a list of key Delaware corporate and commercial decisions that have widespread utility to practitioners, especially those court decisions that are not widely covered by other legal publications or the mainstream press. On a few occasions, I have prepared a mid-year review. This is one of those years.

A few weeks ago, I prepared highlights of key decisions published over the last 6 months or so (and in some instances a little beyond that period), for presentation to a large law firm based on the west coast. I’m “repurposing” my materials for that presentation by providing those case highlights below. For each blurb below, there is a link to a fuller overview as well as a link to the complete court opinion.

HIGHLIGHTS OF RECENT KEY DELAWARE CORPORATE AND COMMERCIAL DECISIONS–as of May 30, 2019

DELAWARE SUPREME COURT DECISIONS

Delaware Supreme Court Clarifies Appraisal Law

The Delaware Supreme Court, in a per curiam decision, recently determined that “deal price less synergies” was the appropriate determination of fair value in the appraisal action before it.  In Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., C.A. No. 11448-VCL (Del. Apr. 16, 2019), the Court reversed the Court of Chancery’s holding that “unaffected market price” was the fair value on the date of the merger. This case is the third in a recent trilogy of precedent-setting Delaware appraisal cases, preceded by DFC Global Corp. v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017) and Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd, 177 A.3d 1 (Del. 2017).  This case has been the subject of extensive commentary by scholars and practitioners in the short time since its publication.

Link: https://www.delawarelitigation.com/2019/04/articles/delaware-supreme-court-updates/delaware-supreme-court-clarifies-appraisal-law/

Company Required to Produce Emails Among Management to Stockholders

The Delaware Supreme Court recently issued an opinion that clarifies the duty of a company to produce emails among its management in a Section 220 case. In KT4 Partners LLC v. Palantir Technologies, Inc., Del. Supr., No. 281, 2018 (Jan. 29, 2019), Delaware’s High Court addressed a demand under Delaware General Corporation Law (DGCL) Section 220 by a stockholder for corporate books and records, including emails among management, to allow the stockholder to investigate possible wrongdoing, such as the reasons behind amendments to an Investors’ Rights Agreement that severely reduced the original rights granted under that agreement.

Notably, the court in its opinion quoted from a law review article that yours truly co-authored on the topic, which explained why demands under DGCL Section 220 should often include electronically-stored information (ESI) such as emails. See footnote 76.

This opinion is noteworthy because it clarifies Delaware law and authoritatively describes those circumstances when a demand for books and records under DGCL Section 220 will require the company to produce ESI, such as emails among management, to the extent necessary for the proper purpose established in a Section 220 case.

Brief Overview:

The stockholder demand in this case stated as its purpose the investigation of mismanagement, including depriving investors of their right of first refusal under an investors’ agreement that was amended without the consent of all investors, as well as interfering with the sale of stock by a large stockholder. The Court of Chancery, in a decision highlighted on these pages, determined that although some books and records had to be produced, emails need not be. The Supreme Court disagreed with that ruling and affirmed in part, reversed in part, and remanded.

Importantly, the facts of this case include an acknowledgment by the company that it often did not follow corporate formalities such as preparing board resolutions and keeping minutes of board meetings, but rather often communicated by email and took action by email–including on matters that were the subject of the investigative purpose of the Section 220 demand.

Highlights of Key Aspects of the Court’s Ruling:

For busy readers, I provide bullet points of key aspects of this crucial decision, but those who need to be familiar with the nuances of this aspect of Delaware corporate litigation should read the entire 49-page opinion linked above.

Procedural Background:

  • The court discussed what appeared to be an issue of first impression about the standard of review regarding a dispute over the interpretation of the stated purpose in a Section 220 demand. The court explained that the standard of review for the scope of relief is abuse of discretion, but de novo review applies to questions of law such as whether the stated purpose under Section 220 is proper. Although contract interpretation is also subject to de novo review as a question of law, fact-intensive and judgment-based determinations are reviewed for abuse of discretion, and factual determinations that underlie the trial court’s interpretation of an ambiguous written document deserve the deference given to factual findings.
  • The Delaware Supreme Court found that the demand in this case did include an explicit reference to a request for electronic documents.
  • The core issue identified by the High Court was whether the Court of Chancery abused its discretion in ruling that emails and other ESI were not necessary to satisfy the purpose of investigating the wrongdoing alleged in this Section 220 case.

Basic Principles:

  • The court reviewed the basic principles and policy undergirding the qualified common law and statutory right to inspect corporate books and records. See Slip op. at 22 to 24.
  • The court observed that the scope of documents to which a stockholder is entitled under Section 220 is limited to those that are necessary to accomplish the proper purpose as stated in the demand. See Slip op. at 24 to 25.

Emails/ESI Production:

  • In explaining why ESI should be included in appropriate Section 220 cases, the Delaware Supreme Court quoted from a law review article on this topic co-authored by your truly. See footnote 76 (quoting Francis G.X. Pileggi, et al., Inspecting Corporate “Books and Records” in a Digital World: The Role of Electronically Stored Information, 37 Del. J. Corp. L. 163, 165 (2012)).
  • The court reviewed Delaware cases that previously addressed whether ESI such as emails should be included in a Section 220 request. See footnotes 71 to 74. See also Amalgamated Bank v. Yahoo!, Inc., a Chancery opinion highlighted on these pages that also cited the same law review article on this topic co-authored by yours truly that was quoted by the Supreme Court in the instant case. See, e.g., footnote 72 (citing a Court of Chancery Order allowing for imaging of a Blackberry in a Section 220 case.)
  • The court also explained, based on the facts and circumstances of this case, why emails and ESI had to be produced and were needed to accomplish the stated purpose. See Slip op. at 31. For example, the court explained that the company involved did not comply with required corporate formalities such as minutes of board meetings and that it often conducted corporate business informally, including over email, regarding the issues subject to the Section 220 demand. See footnote 77 and accompanying text. The ESI at issue included, for example,  an allegedly incriminating message sent via LinkedIn.
  • The court also emphasized that there may be some Section 220 cases where ESI may not be required to be produced by the company, such as those situations where the corporation has traditional, non-electronic documents that are sufficient to satisfy the needs of the Section 220 petitioner.
  • In this case, the company admitted that there were no hardcopy documents that addressed all of the requests, and that there were emails and other ESI that were responsive to the requests.
  • The court also provided practice tips for future litigants: there should be a cooperative effort to focus on the substantive data that should be produced–or in other words, focus on the information that is needed and that is available whether it be in hardcopy or in ESI format.

The court also addressed an unrelated issue. It rejected the argument that the company made that as a condition of production it could require the stockholder to file any suits based on the data received in the Delaware Court of Chancery. Although there have been cases that have imposed similar jurisdictional conditions, the court explained why such a condition should be the exception and not the norm.

SUPPLEMENT: Law360 published an article about this case in which they quoted my comments about the importance of the High Court’s opinion.

Link: https://www.delawarelitigation.com/2019/01/articles/delaware-supreme-court-updates/company-required-to-produce-emails-among-management-to-stockholders/

Supreme Court Explains the Implied Covenant of Good Faith and Fair Dealing

A recent Delaware Supreme Court decision is must-reading for those who need to know the latest iteration of Delaware law on the implied covenant of good faith and fair dealing. In Oxbow Carbon & Minerals Holdings, Inc. v. Crestview-Oxbow Acquisition, LLC, Del. Supr. No. 536, 2018 (Jan. 17, 2019), Delaware’s High Court provided the latest articulation of Delaware law on the multi-faceted doctrine of the implied covenant of good faith and fairing dealing. In connection with affirming in part and reversing in part a 176-page trial court opinion, which was highlighted on these pages, the Supreme Court agreed with the analysis of the trial court’s correct reading of the plain meaning of the LLC agreement at issue, but disagreed with the application by the trial court of the implied covenant.

 Highlights of the most recent authoritative explanation of the implied covenant under Delaware law are noted in the following bullet points:

  • When a board is given contractual discretion to make a choice, that is not a “gap” to be filled. Although “the vesting of a board with discretion does not relieve the board of its obligation to use that discretion consistently with the implied covenant of good faith and fair dealing,” the argument was not made in this case that the board exercised this contractual discretion in bad faith. See footnotes 92 and 93 and accompanying text.
  • The court explained the two common situations where the implied covenant often applies. The first, at issue in this case, is when it is argued that a situation has arisen that was unforeseen by the parties and where the agreement’s express terms do not cover what should happen. See footnote 93.
  • The next situation is when a party to the contract is given discretion to act as to a certain subject and it is argued that the discretion has been used in a way that is impliedly proscribed by the contract’s express terms. Id.
  • “When a contract confers discretion on one party, the implied covenant requires that the discretion be used reasonably and in good faith.” Id.
  • Delaware’s High Court explained that the “implied duty of good faith and fair dealing is not an equitable remedy for rebalancing economic interests after events that could have been anticipated, but were not, later adversely affected one party to a contract.” See footnote 109 and accompanying text.
  • Rather, “the covenant is a limited and extraordinary legal remedy.” See footnote 110.
  • The Supreme Court added that the implied covenant “does not apply when the contract addresses the conduct at issue, but only when the contract is truly silent concerning the matter at hand. Even where the contract is silent, an interpreting court cannot use an implied covenant to re-write the agreement between the parties, and should be most chary about implying a contractual protection when the contract could easily have been drafted to expressly provide for it.” See footnotes 110 to 113 and accompanying text.

Link: https://www.delawarelitigation.com/2019/01/articles/delaware-supreme-court-updates/supreme-court-explains-the-implied-covenant-of-good-faith-and-fair-dealing/

Delaware Supreme Court Clarifies Ab Initio Requirement for BJR Review

The Delaware Supreme Court recently clarified the “ab initio” requirement announced in the Kahn v. M&F Worldwide Corp. case as part of the set of standards that would allow for the BJR standard to apply to a challenged merger. See Olenik v. Lodzinski, No. 392, 2018 (Del. Supr., rev. April 11, 2019).  The High Court determined that the requirement was not satisfied based on the facts of the instant case because the “economic bargaining took place prior to the date” when the protections announced in the Kahn v. M&F Worldwide Corp. case needed to be in place.

Much commentary has already been written about this case, so it will not be covered thoroughly on these pages, but I refer to prior decisions that have applied the ab initio requirement, for background purposes, as noted on these pages.

 Link: https://www.delawarelitigation.com/2019/04/articles/delaware-supreme-court-updates/delaware-supreme-court-clarifies-ab-initio-requirement-for-bjr-review/ 

Supreme Court Affirms Akorn Decision

The Delaware Supreme Court, in Akorn, Inc. v. Fresenius Kabi AG, et al., Del. Supr., No. 535, 2018 (Dec. 7, 2018), affirmed in a 3-page order, two days after oral argument, the Court of Chancery’s 253-page decision which was highlighted on these pages, and which is thought to be the first Delaware decision to find that a “material adverse effect” clause was triggered in such a way as to allow an acquiring party to terminate a merger pre-closing. Much has been written in trade publications about the Akorn case. See, e.g., here and here .

Link: https://www.delawarelitigation.com/2018/10/articles/chancery-court-updates/chancery-allows-termination-of-merger-agreement-based-on-material-adverse-change/

COURT OF CHANCERY DECISIONS

Chancery Instructs on DGCL Merger Requirements

A recent Delaware Court of Chancery opinion began by describing the complaint as reading like a law school exam designed to test the knowledge of a student regarding the requirements in the DGCL that must be satisfied in connection with a merger, and the court commented that the company would not have done well on the exam.

In Mehta v. Mobile Posse, Inc., C.A. No. 2018-0355-KSJM (Del. Ch. May 8, 2019), the court identified the six primary issues in this case as follows:

(1) Whether DGCL Section 262 was not complied with in connection with the failure to notify stockholders of their appraisal rights within the required timeframe;

(2) Whether DGCL Section 228 was not complied with due to the failure to send prompt notice of the written stockholder consents;

(3) Whether the merger agreement, or documents it incorporates, failed to comply with DGCL Section 251 by not including the amount of cash the preferred stockholders would receive for their shares;

(4) Whether the stockholder consents did not enjoy the ratifying effect under DGCL Section 144;

(5)  Whether the director defendants breached their fiduciary duty of disclosure; and

(6) Whether the director defendants breached the fiduciary duty of loyalty because the merger was a self-dealing transaction and not entirely fair.  With one small exception, the court found that the statutory violations were sufficiently established at the early procedural stage of a motion for judgment on the pleadings.

Key Highlights of Decision:

  • As an initial procedural matter, in connection with this motion for judgment on the pleadings, the court observed that it was not well-established in Delaware case law or Rules of Civil Procedure whether a “supplemental notice” attached to a motion for judgment on the pleadings could be considered “part of the record or pleadings.”  Based on this opinion, however, it is now established that under Delaware law, under some circumstances, it is now possible for such a supplemental notice to be included as part of the pleadings in such a procedural posture.  See, e.g., footnotes 1 through 6 and accompanying text.

DGCL Section 262:

  • The company sought a “do-over” or a “mulligan” for its statutory errors, because it purported to send proper notices required by DGCL Section 262–only after suit was filed.  Three problems with that approach are that: (i) Such a “replicated remedy proposal” had never before been blessed by a Delaware court; (ii) Even the supplemental notice proposed was itself wrong (in part because it quoted the statute of another statute); and (iii) trying to make a “supplemental notice” sent after the lawsuit was filed does not always make it part of the pleadings, although as noted above–in some circumstances–based on the opinion in this case, it is now possible to do so.  See Slip op. at 13.

DGCL Section 228:

  • Based on an amendment to the statute passed in 2017, Section 228 no longer requires that the written consent of stockholders be dated next to each signature.  See Slip op. at 19.
  • The court addressed the “less than bright-line rule” about whether or to what extent disclosures are required in connection with written consents of stockholders pursuant to Section 228, but cases cited by the court in this opinion support the view that in this case the company is not entitled to judgment on the pleadings on this issue in light of the lack of material data, or their supplying of incorrect data, with the solicitations for consents that were sent to the minority stockholders in this case.

DGCL Section 228(e)–Prompt Notice Requirement:

  • The prompt notice requirement under Section 228(e) requires that notice of action by written consent of stockholders to those who did not consent must be prompt.  Nonetheless, the exact timetable for such “prompt notice” is not defined in the statute.  One case found that five months was not prompt.  In this matter, notice was given after the Section 262 appraisal deadline, which the court found as a sufficient basis to deny the motion for judgment on the pleadings filed by the company (rather audaciously) in this case.

DGCL Section 251(b):

  • This section of the DGCL requires that a merger agreement include specified details about the deal terms, including compensation to stockholders, but the company failed to comply with this requirement.

DGCL Section 144:

  • The court held that the safe harbor under Section 144(a)(2) was not satisfied in this matter because the stockholders were not given material facts about the interests of the directors in the merger.

The court also denied the company’s motion for judgment on the pleadings regarding claims for breach of fiduciary duty.

Link: https://www.delawarelitigation.com/2019/05/articles/chancery-court-updates/chancery-instructs-on-dgcl-merger-requirements/

Chancery Applies Corporate Advancement Case Law to LLC Context

A recent Delaware Court of Chancery decision interpreted the advancement provisions of an LLC Agreement by applying case law interpreting DGCL Section 145 in the corporate context.  In Freeman Family LLC v. Park Avenue Landing LLC, C.A. No. 2018-0683-TMR (Del. Ch. Apr. 30, 2019), the court reviewed the applicability of “defined phrases” that are familiar prerequisites for advancement in the corporate context pursuant to DGCL Section 145, and analyzed that same language that was used in an LLC agreement provision granting advancement.

The highlights of this decision are based on the assumption that the reader is familiar with the principles of advancement for officers and directors pursuant to DGCL Section 145, and the leading Delaware court decisions on the topic–even if they are not aware that I have written several book chapters on advancement and published multiple articles on advancement and handled many advancement cases.   

 Brief Background:

This case involved a request for advancement by a member (not a manager) of an LLC seeking advancement for the cost of defending a suit in New Jersey brought by the managing member of the LLC relating to the call right of the member under the LLC Agreement.  (The plaintiff-member of the LLC involved in this case was itself an LLC.)

 Issues Addressed:

The two issues that the court addressed in this case are:  (1) Does corporate case law apply to the provisions for advancement in an LLC Agreement which contains language that mirrors the corporate statute, DCGL Section 145; and (2)  Whether the underlying action for which advancement is sought, arises “by reason of the fact” that the party seeking advancement acted in its “official” capacity?  The court answered both questions in the affirmative.

 Highlights of this Decision–Assuming Familiarity with Delaware Corporate Advancement Case Law:

  • The court referenced the well-known truism that advancement cases are particularly appropriate for resolution on a paper record, such as via dispositive motions.  See footnote 22 and accompanying text.
  • The court cited other Delaware cases that have applied corporate case law to analyze the contractual terms of advancement in an LLC Agreement.  See, e.g., Hyatt v. Al Jazeera American Holdings, II, LLC, 2016 WL 1301743 (Del. Ch. Mar. 31, 2016) (highlighted on these pages previously)See also other cases cited at footnotes 36, 37 and 38.
  • The court explained that LLCs and corporations differ most pertinently in regard to indemnification: “mandating it in the case of corporate directors and officers who successfully defend themselves, but leaving the indemnification of managers or officers of LLCs to private contract.”  See footnote 46 and accompanying text.
  • The court recited the guidelines that the Delaware courts used to determine if someone was acting “by reason of the fact”–for purposes of being entitled to either indemnification or advancement, and restated the familiar standard that the operative phrase will be satisfied “if there is a nexus or a causal connection between any of the underlying proceedings and one’s official corporate capacity . . . without regard to one’s motivation for engaging in that conduct.”  See footnotes 50 and 51 and accompanying text.
  • By contrast, the court cited examples of cases where the “by reason of the fact” requirement was not satisfied, which is best exemplified by disputes involving personal contractual obligations that do not involve the exercise of judgment, discretion, or decision-making authority on behalf of the corporation.  See footnote 53 and accompanying text.  Because the party seeking advancement in this case was a member and not an officer or a director, the context was unusual, but the LLC Agreement clearly defined the responsibilities of the member.
  • The court reasoned that the causal relationship between the official capacity of the member and the underlying lawsuit was met for several reasons: (i) The underlying case in New Jersey was about the failure of the member to carry out its responsibilities specified in the LLC Agreement: (ii) The underlying lawsuit in New Jersey is based on whether the member discharged its official duties such that the call rights could be exercised; and (iii) The underlying dispute fully implicates whether or not the member seeking advancement carried out its official duties.  Thus, the court held that the “by reason of the fact” requirement and the “official capacity requirement” were met.
  • The court distinguished five cases in which advancement or indemnification claims were denied because the underlying litigation involved a personal interest that lacked a sufficient connection to official duties.  Those five cases that were distinguished are cited in footnote 56–most of which have been highlighted on these pages:  Bernstein v. TractManager, Inc., 953 A.2d 1003 (Del. Ch. 2007); Cochran v. Stifel Fin. Corp., 2000 WL 1847676 (Del. Ch. Dec. 13, 2000) (rev’d in part on other grounds, 809 A.2d 555 (Del. 2002)); Lieberman v. Electrolytic Ozone, Inc., 2015 WL 5035460 (Del. Ch. Aug. 31, 2015); Dore v. Sweports, Ltd., 2017 WL 45469 (Del. Ch. Jan. 31, 2015); Charney v. Am. Apparel Inc., 2015 WL 5313769 (Del. Ch. Sept. 11, 2015).
  • Regarding whether the “undertaking” provided by the party seeking advancement satisfied the statutory undertaking requirement, the court ruled that the sufficiency of an undertaking is determined by looking at the substance–and not the form alone–of the document containing the undertaking.

 Postscript: It was recently reported by The Chancery Daily that the Vice Chancellor who wrote this opinion published it the day after giving birth to a baby boy. Wow. That’s a dedicated jurist. Congratulations to Her Honor and her family on their new addition.

Link: https://www.delawarelitigation.com/2019/05/articles/chancery-court-updates/chancery-applies-corporate-advancement-case-law-to-llc-context/

Chancery Finds Usurpation of Corporate Opportunity

Delaware case law is well-established regarding the aspect of the fiduciary duty of loyalty that prohibits a corporate director from usurping a corporate opportunity. A recent decision from the Delaware Court of Chancery applies that well-settled prohibition in a flexible manner to a set of facts that have apparently not been squarely addressed in prior precedent.  In Personal Touch Holding Corp. v. Glaubach, C.A. No. 11199-CB (Del. Ch. Feb. 25, 2019), the court awarded damages for the breach of this subset of fiduciary duty, as well as for other breaches of fiduciary duty.

Basic Background Facts:

This case involved a co-founder who also served as a president and director of a New York-based provider of healthcare services. He was removed when the company discovered various transgressions. The former director purchased an office building in his individual capacity–secretly–even though the court found that the former director had been aware that the company was interested for several years in purchasing a similar building for its own use.  The former director then offered to lease the building back to the company at what the court found to be above-market rental rates.

Key Principles of Law:

This short blog post assumes that readers are familiar with the basic principles involved with the usurpation of corporate opportunities, and will merely highlight some of the key statements of law and the court’s reasoning in this 84-page opinion.

The well-known elements of a claim based on the corporate opportunity doctrine have been stated frequently in prior Delaware cases. Those familiar with corporate litigation will recognize the following four elements of a claim for usurpation of corporate opportunity:

“ (1)      The corporation is financially able to exploit the opportunity;

(2)      The opportunity is within the corporation’s line of business;

(3)      The corporation has an interest or expectancy in the opportunity;

(4)      By taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation.”

Slip op. at 36-38.

The court explained that Delaware Supreme Court decisions have referred to some of these elements in the disjunctive even though they are often quoted as being conjunctive. Specifically, proof of either the third element or the fourth element would sustain a corporate opportunity claim.

Moreover, the court decides the viability of a corporate opportunity claim by weighing the four factors in a holistic fashion and no one factor is dispositive. Id.

Key Reasoning of the Court:

  • The court rejected the argument that the purchase of the office building was not in the line of business of the healthcare company involved, which historically leased office space, because the “line of business factor” was in either inapplicable or was satisfied because the company had a clear “interest and expectancy” in the opportunity. In addition to that factor having a flexible meaning, the court explained that latitude should be allowed for development and expansion of a business, and the Delaware courts have broadly interpreted the nature of the corporation’s business when determining whether a corporation had an interest in a opportunity.
  • Regardless, the court found that the line of business test was not relevant where, as here, the company had a clear interest and expectancy in acquiring the building, and the opportunity presented related to an operational decision about how to expand the business as opposed to an opportunity to acquire a new business.
  • The court further reasoned that even if the opportunity was not within the existing line of business, it was sufficient that the company had a “clear interest and expectancy” at the time the opportunity arose. Id. at 44-47.
  • Regarding the fourth factor, the court instructed that a corporate officer or director was prohibited from taking an opportunity for his own “if the corporate fiduciary will thereby be placed in a position inimicable to his duties to the corporation.”
  • The court elaborated by observing that the corporate opportunity doctrine is implicated where the fiduciary’s seizure of an opportunity results in a conflict between the fiduciary’s duties to the corporation and the self-interest of the director as actualized by the exploitation of the opportunity.” Id. at 47-49.
  • The court also rejected an argument that the employment agreement of the former director allowed him to pursue other business interests outside of the company, and to devote a material portion of his time to other business interests. The court found that contractual defense to be unavailing in part because that provision did not allow the defendant to compete with the company for opportunities in which the company had an interest or expectancy. In addition, the employment agreement also prohibited the former director and president from engaging in activities which were “competitive with” the business of the company.
  • The court applied the entire fairness test because the former director was on both sides of the transaction involving a lease of the building to the company, and also because the director received a personal benefit from the transaction that was not received by the shareholders generally. Id. at 53.
  • The court also explained that charging the company an above-market rate for rent was unfair self-dealing and a breach of the duty of loyalty–regardless of whether the former director acted in subjective good faith.

As a side note, the court also found a separate breach of fiduciary duty as a result of the former director engaging in a “letter-writing campaign” over a several month period in which the former director sent harassing and disturbing anonymous letters to board members, employees and the lender of the company which caused harm to the company by hurting morale and causing distraction–in addition to attempting to sabotage the company’s relationship with its primary lender. Slip op. at 76-83.

Link: https://www.delawarelitigation.com/2019/03/articles/chancery-court-updates/chancery-finds-usurpation-of-corporate-opportunity/

Chancery Clarifies Director’s Right to Corporate Records

A recent Delaware Court of Chancery decision addressed the important issue of the right of directors to be given access to corporate records. In Schnatter v. Papa John’s International, Inc., C.A. No. 2018-0542-AGB (Del. Ch. Jan. 15, 2019), Delaware’s court of equity considered a claim under Section 220(d) of the Delaware General Corporation Law (DGCL) by the founder and largest stockholder of the Papa John’s pizza chain who was forced out as the CEO but retained his position as a director.  He sought to obtain books and records in his capacity as a director to support an investigation that the other directors breached their fiduciary duties by improperly ousting him for unjustified reasons.

Key Bullet Points that Make this Case Noteworthy include the following:

  • The court required the Defendant-Directors to produce their text messages and their private emails, that they sent and received, that related to the specific issues in contention. Prior Chancery decisions have required the production of such personal communications that related to corporate business but such a ruling is still notable. For example, a few years ago, in Amalgamated Bank v. Yahoo!, Inc., highlighted on these pages, the Court of Chancery ordered a similar scope of production–and also cited to a law review article that yours truly published in which my co-authors and I explained why electronically stored information (ESI), including text messages and private emails, should often be included within the scope of a DGCL Section 220 demand. See law review article co-authored by yours truly which argued that the court should often include ESI as part of the obligation to produce records under Section 220. See 37 Del. J. Corp. L. 163, 165 (2012), highlighted on these pages here.
  • It is well-established that directors have nearly unfettered rights to access to books and records of a corporation in which they serve. Unlike a stockholder, when a director makes a demand for books and records under Section 220(d), the corporation has the burden to establish that the director’s demand for books and records is based an improper purpose.
  • Unlike the impact of a stockholder filing a plenary action before a Section 220 case is complete, when a director files a plenary action before a final ruling in a Section 220 case, that will not necessarily bar the continuation of Section 220 claims and it will not otherwise moot the Section 220 claims. See generally CHC Investments, Inc. v. FirstSun Bancorp, C.A. No. 2018-0610-KSJM (Del. Ch. Jan. 24, 2019)(Section 220 stockholder demand case dismissed due to parallel plenary action.)
  • The court observed that a director should not be required to sign a confidentiality agreement as a condition to obtaining records because a director already has a fiduciary duty to keep them confidential—as compared to stockholders who routinely are required to sign a confidentiality agreement as a condition to obtaining records pursuant to a Section 220 demand. See generally Murfey v. WHC Ventures, LLC, C.A. No. 2018-0652-MTZ (Del. Ch., Jan.23, 2019)(proposed confidentiality order rejected by Court as non-compliant with Chancery Rule 5.1 because it did not allow for filing confidential documents with the court–confidentially.)

Link: https://www.delawarelitigation.com/2019/01/articles/chancery-court-updates/chancery-clarifies-directors-right-to-corporate-records/

Advancement for Counterclaims Granted Despite Withdraw of Covered Claim

A recent transcript ruling by the Delaware Court of Chancery in Gasgarth v. TVP Investments, LLC, C.A. No. 2018-0621-JTL, transcript ruling (Del. Ch. Dec. 7, 2018), explained that the right to advancement was not extinguished by an amendment of a counterclaim to specifically withdraw breaches of fiduciary duty counterclaims and remove factual allegations relating to the service of the plaintiffs (counterclaim defendants) as directors and officers.

The court reasoned that it is not bound by the four-corners of a pleading, but rather will view the context of the litigation as a whole to determine if advancement is warranted in light of all the facts and circumstances of the case and the role that the directors and officers played in connection with the claims against them.

Relying on Delaware precedent, the court in this transcript ruling also included as part of the “fees on fees” awarded, a success bonus, which was part of the engagement letter with counsel.

Link: https://www.delawarelitigation.com/2019/01/articles/chancery-court-updates/advancement-for-counterclaims-granted-despite-withdraw-of-covered-claim/

Chancery Addresses “Commercially Reasonable Efforts” Standard

When the phrase “commercially reasonable efforts” appears as a standard of performance in contracts, it seems predetermined to generate litigation, and the recent Court of Chancery decision in Himawan v. Cephalon, Inc., C.A. No. 2018-0075-SG (Del. Ch. Dec. 28, 2018), supports that observation. Although the agreement in this case had a contractual definition for “commercially reasonable efforts”, prior Delaware decisions highlighted on these pages that discuss this phrase should be of relevance to anyone who needs to know what the Delaware cases say about this somewhat amorphous standard, and similarly-phrased “efforts clauses”.

Why this decision is noteworthy: The most notable aspect of this decision is its collection of Delaware cases interpreting various iterations of “efforts clauses”. See footnotes 83 to 85.

Brief overview: This case involved an earn-out dispute and a claim by the seller that it did not receive milestone payments pursuant to an earn-out provision because the buyer did not use commercially reasonable efforts to reach the milestones. The buyer was the pharmaceutical company Cephalon, but Teva Pharmaceuticals later bought Cephalon. The product at issue was an antibody that would allow an organism’s immune system to overcome disease-causing pathogens. As with new drugs, the process to bring antibodies to market is long, difficult and risky.

The earn-out in the merger agreement in this case was payable upon the meeting of certain milestones in the process of obtaining  approval by government agencies for the antibody to treat two different conditions. The buyer agreed to use “commercially reasonable efforts” to develop the antibody and achieve those milestones. The seller claims that the buyer did not comply with that efforts clause.

Key takeaways:

  • The Court provides an excellent collection of Delaware decisions that have wrestled with various permutations of “efforts clauses”. See footnotes 83 to 85 and accompanying text. The Court categorizes the collected decisions into the following groups, some of which are overlapping: (i) motions to dismiss (at the pleadings stage); (ii) post-trial decisions; (iii) post-merger decisions (often involving a related earn-out clause); and (iv) pre-merger decisions where the efforts clause applied to the satisfaction of a condition to closing.
  • The agreement involved in this case provided a contractual definition for “commercially reasonable efforts” as follows: “the exercise of such efforts and commitment of such resources by a company with substantially the same resources and expertise as [Cepahlon], with due regard to the nature of efforts and cost required for the undertaking at stake.”
  • The Court observed that the parties agreed that the foregoing is an “objective standard”, but the Court described the contractual definition as “inartfully” drafted and ambiguous. Also, in the context of denying a Motion to Dismiss this claim, the Court found that neither side offered a reasonable interpretation of this contract provision (as compared to another basis to deny an MTD: when both sides offer reasonable, but differing, interpretations.)
  • Based on Delaware’s version of Rule 12(b)(6)–which is not as stringent as the current Federal standard–the Court found that there was a “reasonably conceivable set of circumstances susceptible of proof” in which (allowing for factual issues at this early stage of the case), it could be shown that companies with similar resources and expertise as Cephalon are currently developing treatments for a similar antibody as the one at issue in this case.

Link: https://www.delawarelitigation.com/2018/12/articles/chancery-court-updates/chancery-addresses-commercially-reasonable-efforts-standard/

Chancery Rules on Limits of Forum-Selection Clauses in Corporate Documents

A recent seminal decision of the Delaware Court of Chancery must be included in the lexicon of every lawyer who wants to understand the boundaries of Delaware law on forum-selection clauses in corporate documents. In the case of Sciabacucchi v. Salzberg, C.A. No. 2017-0931-JTL (Del. Ch. Dec. 19, 2018), the Court determined that a forum-selection clause in a certificate of incorporation was invalid and ineffective to the extent that it purported to “require any claim under the Securities Act of 1933 to be brought in federal court” (the “Federal Forum Provisions”).

Why this Case is Noteworthy: The court reasoned in its holding that: “The constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.  In this case, the Federal Forum Provisions attempt to accomplish that feat.  They are therefore ineffective and invalid.

Overview of Key Points:

This opinion is destined to form part of the bedrock of foundational Delaware corporate decisions and could rightly be the subject of a lengthy law review article, but for purposes of this quick blog post, I will merely highlight a few of the more notable excerpts in bullet points.

  • A substantial basis for the court’s reasoning was a prior decision from the Court of Chancery which upheld the validity of corporate bylaws that required claims based on the internal affairs doctrine and related claims to be brought exclusively in the Court of Chancery. That decision by the current Chief Justice of Delaware, writing at the time as the Chancellor, was Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. June 25, 2018).
  • Although the Boilermakers case involved bylaws, the Sciabacucchi decision explained why that same reasoning applied to a certificate of incorporation which is governed by similar provisions in the Delaware General Corporation Law (DGCL). The court in Sciabacucchi explained that the reasoning in Boilermakers focused on the ability to enforce forum-selection clauses that related to the internal corporate matters of a Delaware corporation as opposed to external matters, such as claims arising under the Securities Act of 1933.
  • The Court buttressed its reasoning by referring to the codification of the Boilermakers decision, shortly after its publication, by means of the adoption of a new Section 115 of the DGCL. In connection with that new DGCL section, the Delaware General Assembly also passed new amendments to Sections 102 and 109 of the DGCL which prohibit fee-shifting provisions in the certificate of incorporation or bylaws particularly in connection with claims related to the internal affairs of a corporation as defined by DGCL Section 115.
  •  The Court’s reasoning was also supported by reference to what the court referred to as “first principles.” Those first principles included several basic tenets of corporate law such as the following: (i) Although the document filed with the state that gives rise to an artificial entity such as a corporation, and confers powers on it, is a contract, it is not an ordinary private contract among private actors; (ii) The certificate of incorporation is a multi-party contract that includes the State of Delaware. Unlike an ordinary contract, it also includes terms by reference that are imposed by the DGCL; (iii) Unlike an ordinary contract, a charter can only be amended to the extent that it complies with the DGCL; (iv) The DGCL specifies what provisions a charter may or may not include; and (v) Although the courts enforce both types of contracts, when enforcing relationships created by the corporate contract, the courts use an overlay of fiduciary duty. See pages 38 to 42 and footnotes 111 to 125.
  • A thorough analysis of the contours and policy behind the internal affairs doctrine is an important feature of this opinion. See, e.g., pages 41-46.

In sum, the court reasoned that the “constitutive documents of a Delaware corporation cannot bind the plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.” The opinion provides extensive citations to substantial scholarship, case law and statutes.

Prof. Ann Lipton provides extensive insights in her blog post about this case with links to her articles on the topic. The good professor’s scholarship on this issue was also cited by the court in the above opinion.

Many cases have been highlighted on this blog regarding forum-selection clauses in private agreements. See, e.g., here and here. In some of the posts on these pages about cases involving forum-selection clauses, a graphic of the Roman Forum adds color as well as an etymological connection.

SUPPLEMENT: Professor Stephen Bainbridge, a prolific corporate law scholar, kindly links to this post on his blog.

Link: https://www.delawarelitigation.com/2018/12/articles/chancery-court-updates/chancery-rules-on-limits-of-forum-selection-clauses-in-corporate-documents/

A recent Delaware Court of Chancery decision interpreted the advancement provisions of an LLC Agreement by applying case law interpreting DGCL Section 145 in the corporate context.  In Freeman Family LLC v. Park Avenue Landing LLC, C.A. No. 2018-0683-TMR (Del. Ch. Apr. 30, 2019), the court reviewed the applicability of “defined phrases” that are familiar prerequisites for advancement in the corporate context pursuant to DGCL Section 145, and analyzed that same language that was used in an LLC agreement provision granting advancement.

The highlights of this decision are based on the assumption that the reader is familiar with the principles of advancement for officers and directors pursuant to DGCL Section 145, and the leading Delaware court decisions on the topic–even if they are not aware that I have written several book chapters on advancement and published multiple articles on advancement and handled many advancement cases.   

Brief Background:

This case involved a request for advancement by a member (not a manager) of an LLC seeking advancement for the cost of defending a suit in New Jersey brought by the managing member of the LLC relating to the call right of the member under the LLC Agreement.  (The plaintiff-member of the LLC involved in this case was itself an LLC.)

Issues Addressed:

The two issues that the court addressed in this case are:  (1) Does corporate case law apply to the provisions for advancement in an LLC Agreement which contains language that mirrors the corporate statute, DCGL Section 145; and (2)  Whether the underlying action for which advancement is sought, arises “by reason of the fact” that the party seeking advancement acted in its “official” capacity?  The court answered both questions in the affirmative.

Highlights of this Decision–Assuming Familiarity with Delaware Corporate Advancement Case Law:

·     The court referenced the well-known truism that advancement cases are particularly appropriate for resolution on a paper record, such as via dispositive motions.  See footnote 22 and accompanying text.

·     The court cited other Delaware cases that have applied corporate case law to analyze the contractual terms of advancement in an LLC Agreement.  See, e.g., Hyatt v. Al Jazeera American Holdings, II, LLC, 2016 WL 1301743 (Del. Ch. Mar. 31, 2016) (highlighted on these pages previously)See also other cases cited at footnotes 36, 37 and 38.

·     The court explained that LLCs and corporations differ most pertinently in regard to indemnification: “mandating it in the case of corporate directors and officers who successfully defend themselves, but leaving the indemnification of managers or officers of LLCs to private contract.”  See footnote 46 and accompanying text.

·     The court recited the guidelines that the Delaware courts used to determine if someone was acting “by reason of the fact”–for purposes of being entitled to either indemnification or advancement, and restated the familiar standard that the operative phrase will be satisfied “if there is a nexus or a causal connection between any of the underlying proceedings and one’s official corporate capacity . . . without regard to one’s motivation for engaging in that conduct.”  See footnotes 50 and 51 and accompanying text.

·     By contrast, the court cited examples of cases where the “by reason of the fact” requirement was not satisfied, which is best exemplified by disputes involving personal contractual obligations that do not involve the exercise of judgment, discretion, or decision-making authority on behalf of the corporation.  See footnote 53 and accompanying text.  Because the party seeking advancement in this case was a member and not an officer or a director, the context was unusual, but the LLC Agreement clearly defined the responsibilities of the member.

·     The court reasoned that the causal relationship between the official capacity of the member and the underlying lawsuit was met for several reasons: (i) The underlying case in New Jersey was about the failure of the member to carry out its responsibilities specified in the LLC Agreement: (ii) The underlying lawsuit in New Jersey is based on whether the member discharged its official duties such that the call rights could be exercised; and (iii) The underlying dispute fully implicates whether or not the member seeking advancement carried out its official duties.  Thus, the court held that the “by reason of the fact” requirement and the “official capacity requirement” were met.

·     The court distinguished five cases in which advancement or indemnification claims were denied because the underlying litigation involved a personal interest that lacked a sufficient connection to official duties.  Those five cases that were distinguished are cited in footnote 56–most of which have been highlighted on these pages:  Bernstein v. TractManager, Inc., 953 A.2d 1003 (Del. Ch. 2007); Cochran v. Stifel Fin. Corp., 2000 WL 1847676 (Del. Ch. Dec. 13, 2000) (rev’d in part on other grounds, 809 A.2d 555 (Del. 2002)); Lieberman v. Electrolytic Ozone, Inc., 2015 WL 5035460 (Del. Ch. Aug. 31, 2015); Dore v. Sweports, Ltd., 2017 WL 45469 (Del. Ch. Jan. 31, 2015); Charney v. Am. Apparel Inc., 2015 WL 5313769 (Del. Ch. Sept. 11, 2015).

·     Regarding whether the “undertaking” provided by the party seeking advancement satisfied the statutory undertaking requirement, the court ruled that the sufficiency of an undertaking is determined by looking at the substance–and not the form alone–of the document containing the undertaking. 

Postscript: It was recently reported by The Chancery Daily that the Vice Chancellor who wrote this opinion published it the day after giving birth to a baby boy. Wow. That’s a dedicated jurist. Congratulations to Her Honor and her family on their new addition.

A recent decision by the Delaware Court of Chancery contrasted the difference between advancement rights based on an L.P. agreement as compared to the right of a corporate director or officer to receive advancement of fees and costs to defend a lawsuit. In Weil v. VEREIT Operating Partnership, L.P., C.A. No. 2017-0613-JTL (Del. Ch. Feb. 13, 2018), the court also distinguished between the different procedural and substantive aspects of an indemnification claim as compared to an advancement claim. This opinion provides important statements of the law and nuances of practical value to those engaged in this frequent subject of Delaware corporate and commercial litigation.

Also, unlike the claims in the context of an alternative entity such as an L.P. agreement, Delaware General Corporation Law (DGCL) Section 145 provides certain “default boundaries” that are not necessarily applicable to an advancement claim based on pure contract terms in the L.P. context. Unlike rights based on an L.P. agreement, generally speaking, once there is an advancement right in the corporate context, DGCL section 145 imposes certain restrictions on the corporation that attempts to deny those rights. See, e.g., one of the three decisions in the Holley v. Nipro cases highlighted on these pages. The Holley decisions provide helpful basic and nuanced principles on this topic.

For those who need to know the latest iteration of Delaware law on advancement and how it differs from indemnification in the L.P. context, this 37-page opinion with over 70 footnotes is required reading. For purposes of this short blog post that is intended for busy corporate litigators, I provide highlights of the decision:

Background:

  • The procedural context of this case was a motion for summary judgment which featured 55 exhibits. There were multiple parties involved and several different entities–only some of whom were entitled to advancement or indemnification under the applicable alternative entity agreements.
  • Because this advancement claim was based on an alternative entity agreement, as opposed to corporate documents that were subject to the default constraints of DGCL section 145, the primary framework of the analysis was contractual and not statutory. The court provides a comprehensive review of the detailed factual setting which is necessary to grasp for a complete understanding of the case.

Key Legal Principles:

  • The court referred to Section 17-108 of the Delaware Revised Uniform Limited Partnership Act which gives a limited partnership the power to indemnify any partner or other person, and also includes an empowerment to provide for advancement. Section 17-108 defers completely to the contract of the parties to create rights and obligations with respect to indemnification and advancement of expenses.
  • Importantly, Section 17-108 of the LP Act gives limited partnerships wider freedom of contract to draft their own framework for indemnification and advancement than is available to corporations under Section 145 of the DGCL, which creates mandatory indemnification rights for corporate indemnities in some circumstances–and also bars indemnification in others. See footnote 8 for supporting cases.
  • The court provided a thorough contractual analysis of the advancement and the indemnification provisions in the LP agreement. The court noted the tension and lack of consistency in the LP agreement between the provisions for advancement and the legally quite distinct conceptual analysis of indemnification. The agreement here appeared to describe differently those covered by advancement and indemnification.
  • The court emphasized the important distinctions between an analysis for advancement, which is a summary proceeding where the only question involves the extension of credit, and a completely separate procedural and substantive analysis of indemnification.
  • In advancement cases, when there is an issue whether someone is sued in a covered or non-covered capacity, the court will generally resolve the doubt in favor of advancement, and defers until the subsequent indemnification analysis whether or not the advanced funds might later be subject to disgorgement if a party is later determined to be ineligible for indemnification. See footnotes 20 through 23.
  • The court distinguished the case of Fasciana v. Electronic Data Systems Corp. (“Fasciana I”) 829 A.2d 160 (Del. Ch. 2003), because that case dealt with the determination of who was a “agent” for indemnification purposes under Section 145, but this case focuses on advancement.
  • Based on the contractual basis on which the advancement claims were made in this case, the court analyzed and applied the defined terms, whose definitions were not the model of clarity. See footnotes 28 and 29 and accompanying text.

Specific Disputes About Allocation of Which Fees are Covered

  • Although the parties seemed to acknowledge that there was a right to some advancement, the challenges were based on whether or not all of the fees demanded were properly allocated among covered and non-covered proceedings, as well as covered and non-covered persons.
  • Consistent with prior case law, the court explained that the court will not engage in a line by line review of bills to determine if allocation was proper between covered and non-covered persons or proceedings, and will rely on the certification of senior counsel involved at the advancement stage of the proceedings.
  • The court will wait for the indemnification stage to determine a more specific allocation of what fees were incurred for covered parties and which would be allocated to non-covered parties. See footnotes 33 to 39 and accompanying text.
  • Nonetheless, the court emphasized that an effort must be made to allocate fees, to the extent possible, between those incurred for covered persons and underlying covered proceedings, and those fees incurred for persons or proceedings that are not covered by advancement. See footnote 40.

Unilateral Imposition of Conditions to Payment Rejected:  

  • This is an important principle that should have widespread application even outside the alternative entity context: A company cannot unilaterally impose conditions on advancement that are not contained in the underlying documents on which advancement is based. For example, in this case the court rejected efforts by the company to impose a litigation budget or impose billing guidelines as a condition for advancement because those conditions were not included in the advancement provision of the LP agreement. See footnotes 46 to 48 and accompanying text.
  • Likewise, the court rejected an argument that a company could refuse to pay for annual increases in hourly rates. No such limitation was in the L.P. Agreement.
  • Regarding invoices from third-parties, the court determined that at the advancement stage, it was sufficient to rely on the verification of a senior attorney involved that those invoices were necessary and reasonable.

Reasonableness of Total Fees:

  • The limited partnership agreement allowed for advancement of “reasonable expenses.” Consistent with Court of Chancery Rule 88, as well as Delaware Lawyers’ Rule of Professional Conduct 1.5(a), the court explained that the fees requested must be reasonable in amount based on the eight factors applied under Rule 1.5(a) to make that determination.
  • Nonetheless, the court will not review each line item or time entry and disbursement, nor will it second-guess the judgment of lawyers on the appropriate staffing of the case at the advancement stage.
  • The parties do not have a blank check in this context, however, and the amount of fees are subject to review again at the indemnification stage. The court also observed that the client should also serve as a level of review because until indemnification is decided, that person incurs the risk that the fees may need to be paid back.
  • Regarding the challenge to the rates charged by staff attorneys, the court found that there were factual issues that could not be resolved at summary judgment stage.
  • Regarding allegations that the hours worked on the case were excessive and that the Paul Weiss firm overstaffed the matter, the court determined that it would rely on a certification from a senior partner of Paul Weiss by sworn affidavit that the amount of fees and expenses were reasonable under the circumstances.
  • The court emphasized however that the firm does not have a blank check and that the person receiving the advancement has an incentive to monitor those bills in the event that it may be ultimately determined that the advancement was improvidently granted and may later need to be disgorged. Thus a more detailed review of fees alleged to be excessive is deferred until the indemnification stage, at which time levels of staffing and number of hours worked and rates can be reviewed.

Procedure for Determining Advancement Due on Future Invoices:

  • The court described at pages 32 through 37 of the slip opinion the detailed procedure that the court required to be followed going forward based on the very specific methods described in the Fitracks case which is a very comprehensive procedure designed to minimize the amount of disputes about monthly bills that the court will need to address going forward.

Regarding Fees on Fees:

  • The court determined that because only some of the claims were successful, only a partial amount of fees on fees would be awarded and that the parties should use the same Fitracks procedure to determine those amounts.

The most noteworthy point of this short letter ruling in which a former corporate officer is granted advancement pursuant to Section 145 of the Delaware General Corporation Law, in Kolokotrones v. Ninja Metrics, Inc., C.A. No. 12413-VCS (Del. Ch. Dec. 18, 2017), is that the court rejected an argument based on the fact that the underlying litigation for which advancement was sought had been concluded by the time that a formal order granting advancement was entered on the docket.  Although in theory, when the underlying claim that gave rise to any advancement right was dismissed or finally concluded, arguably that claim for advancement then became a claim for indemnification, assuming that the party seeking advancement prevailed, the court found that argument unpersuasive based on the procedural posture of this case.

The court explained that otherwise it would be placing form over substance and benefiting the defending party for its procedural “machinations.” In addition, the court did not want to reward the delay of the defending party to the detriment of the party seeking advancement.

Moreover, the original decision in this case was rendered as a bench ruling, and the letter ruling that denied a motion for reargument explained that the original decision had granted fees on fees. Thus, notwithstanding a prior final resolution of the underlying litigation that gave rise to the advancement claim, because fees on fees were granted for the advancement claim, simply because the underlying litigation concluded, does not, in the court’s words:  “under any view of the world, moot that claim.”

In a recent Delaware Chancery opinion, the court clarified that a corporate officer who was “successful on the merits or otherwise in the defense of an action” need not show good faith in order to be entitled to mandatory indemnification.  Meyers v. Quiz-Dia LLC, C.A. No. 9870-VCL (Del. Ch. June 6, 2017). See also DGCL Section 145(c). Several prior Delaware decisions in this case, which provide background details, have been highlighted on these pages.

Key Aspects of the Decision:  Many cases highlighted on this blog have addressed the various permutations of indemnification and advancement for officers and directors, so this decision will be limited to the nuances that make this ruling noteworthy (and “blog-worthy”).

The court explained that when mandatory indemnification is provided to the fullest extent permitted by applicable law, that includes the fees incurred to investigate claims  prior to a lawsuit.  In particular, in this matter, former officers had reason to believe that they would be sued, and thus began an investigation of those potential claims in order to prepare their defense.  Fees for that investigation are included in the indemnification rights to which they were entitled.

Although the indemnification provisions in this case were in the LLC context, because the language used in the LLC documents mirrored DGCL Section 145(c), the case law and statutory interpretation approach that construed that language was applicable.

The phrase in Section 145(c) that provides mandatory indemnification when a former director or officer has been “successful on the merits or otherwise in defense of any action . . ..”, has been interpreted very broadly to include almost anything short of a complete loss.  It permits an indemnitee to be indemnified as a matter of right even if the success includes, for example, dismissal without prejudice of a federal action – – and the same claims are later asserted again in a state court action.

Notably, the good faith requirement does not apply under Section 145(c) to a director or an officer who is “successful” in defending a claim.  See footnotes 39 and 40 and accompanying text.

An associate in the Delaware office of Eckert Seamans prepared this overview.

The Court of Chancery opinion in Horne v. OptimisCorp, C.A. No. 12268-VCS (Del. Ch. Mar. 3, 2017) explores Delaware’s indemnification provisions.

Background:  Plaintiff William Horne (“Horne”) brought an action for indemnification for fees and expenses against OptimisCorp (the “Company”).  Horne’s fees stemmed from an action brought against him by the controlling stockholder of the Company, Alan Morelli (“Morelli”), which alleged Morelli was wrongfully removed from the board of directors and as the Company’s CEO.   After a six-day trial, the Court of Chancery found that Morelli failed to prove any of his claims.  Horne then filed for indemnification of his expenses incurred to defend the action brought by Morelli.  The Company opposed those expenses, arguing that they were not incurred by reason of the fact that Horne was an officer of the Company, and also that the amount of fees was unreasonable.

Analysis:  The court began its analysis by quoting DGCL Section 145(c), which states in part that present or former officers and directors that have been successful on the merits or otherwise shall be indemnified against expenses (including attorneys’ fees) actually and reasonably incurred.

To determine whether Horne can satisfy the “by reason of the fact” standard, the court explained that only a nexus or causal connection between the underlying proceedings and one’s official corporate capacity is needed.  This test was easily met by Horne, because claims were brought against him for breach of fiduciary duty in his role as the Company’s CFO.  A claim for aiding and abetting was also brought “by reason of the fact” that Horne was the CFO, because the underlying conduct was consistent with his fiduciary duties.

Moving to reasonableness of the fee amount, the court stated that it considers three factors: (1) whether the expenses were actually paid; (2) if the services were in good faith, thought prudent, and appropriate by competent counsel; and (3) the rates charged were comparable to similar circumstances.

The Company only challenged the second factor.  The Company asserted that Horne’s litigation strategy racked up a considerable amount in fees, but was largely abandoned prior to trial.  The court remarked that it would review a litigation strategy only if those decisions are “unmistakably unreasonable.”  And the court will not engage in a line-by-line review of bills.  Therefore, the court rejected this argument in whole and award Horne with full indemnification.

The Delaware Court of Chancery recently addressed an issue of importance to directors of companies as well as those interested in corporate litigation. In the case of Dore v. Sweports, Ltd., C.A. No. 10513-VCL (Del. Ch. Jan. 31, 2017), the court addressed situations where a director conceivably could be indemnified for fees incurred in pursuing an affirmative claim against the company as compared to the typical situation where indemnification is sought for reimbursement of fees incurred to defend a claim successfully. This opinion also provides an excellent overview of basic indemnification principles based on DGCL Section 145.

Background: The various lawsuits that gave rise to this indemnification action were based in large part on the attempts of the law firm of Sweports, Ltd. to collect legal fees.  One of the partners in the law firm was on the board of the company and also had to defend himself when the company filed counterclaims against the plaintiffs that were unsuccessful.  The lawyers who were seeking to collect their fees against the company ultimately commenced involuntary bankruptcy proceedings against the company.  The Delaware lawsuit was initiated after the lawyers for the company were largely successful in their lawsuits against the company to collect fees, and in defending claims against them made by the company.

Indemnification Principles

Section 145(a) of the Delaware General Corporation Law (DGCL) allows for indemnification in an action “other than by or in the right of the corporation.”  Section 145(b) provides for indemnification in an action “by or in the right of the corporation.”  Section 145(c) mandates that a Delaware corporation indemnify an individual who was sued by reason of the fact that the individual served as a director or officer if the individual was successful on the merits or otherwise in defending against the claim.  Although Section 145(c) only covers directors and officers, when a corporation has provided other authorized individuals with mandatory indemnification to the fullest extent of the law, then that right extends the mandatory indemnification contemplated by Section 145(c) to those individuals.

When assessing an indemnification claim, typically the first inquiry is whether the expense has been incurred in connection with a covered proceeding.  A covered proceeding is a civil, criminal, administrative or investigative action in which the individual seeking indemnification was a “party or threatened to be made a party by reason of the fact that the individual is or was a director, officer, employee or agent of the corporation.”  The corporation has the burden of proof when it has provided individuals with mandatory indemnification to the fullest extent of the law, to prove that an individual is not entitled to indemnification.

Typically, step two in the analysis after it is determined that a proceeding is covered, is to analyze whether the expenses incurred “were actually and reasonably incurred” in connection with the proceeding.  The court determined that only a small fraction of the expenses sought were actually incurred, and some of the expenses claimed were inflated.

The key aspect of this 58-page opinion of the Delaware Court of Chancery that makes it notable is that it addresses those situations in which an affirmative claim is indemnifiable, as compared with the more common claim for indemnification based on fees and expenses incurred to defend a claim brought against a director.

In this opinion, the Vice Chancellor explained that “it is conceivable that indemnification might be warranted for preemptive litigation involving personal claims that sought to negate a threatened breach of fiduciary duty claim . . ..”  The court explained that “. . . indemnification might be available if disposition of the personal claims would determine definitively whether the plaintiffs had breached their fiduciary duties.”  Typically, indemnification claims are not allowed for personal claims that are not brought “by reason of” the director’s duties, for example, in connection with an employment agreement that does not involve the exercise of judgment, discretion, or decision-making authority on behalf of the corporation.  The court referred to a prior Delaware decision in which indemnification was permitted for an intervenor where collateral estoppel might have barred a claim in a subsequent proceeding.

In this case, the plaintiffs chose to pursue their claims based on pure breach of contract theories untethered to their conduct as fiduciaries of Sweports.  Although they could have proceeded in a different manner, they only proceeded on a breach of contract theory.  The contract claims were personal to the plaintiffs in their capacity as lenders, creditors and guarantors – – which did not have a sufficient nexus implicating corporate duties.

The court did allow a portion of the fees and expenses incurred to defend against counterclaims which plaintiffs successfully defended, as well as related claims that were defensive in nature.  Finally, because the plaintiffs were only successful to a small degree in their claims seeking indemnification, the court only allowed a small percentage of the “fees on fees” that were incurred in connection with their effort in this case to collect fees.

Postscript: For the past several years, I have co-written a chapter of a book published by the ABA that compiles key court decisions from Delaware and around the country regarding both advancement and indemnification of corporate officers and directors, for example, pursuant to DGCL section 145.

The Delaware Supreme Court explains in this short opinion the public policy supporting the expedited nature of advancement proceedings for officers and directors of corporations, and managers of LLCs. Trascent Mgmt. Consulting, LLC v. Bouri, No. 126, 2016, 2016 WL 6947014 (Del. Nov. 28, 2016).

Although the principles discussed in this opinion are not new, the result of the case is a predictable rejection of a defense to payment by an entity of advancement of fees incurred by former officers, directors and managers. This is an essential topic in corporate litigation for executives of companies and the lawyers who represent them.  We include this decision on these pages, as it is the most recent Supreme Court pronouncement on an exceedingly important topic, and we cover on this blog the key decisions in the area. The most noteworthy aspect of this opinion is the court’s explanation of the public policy reasons in support of advancement and the need for prompt resolution of such claims in the Court of Chancery.dollar-941246_1280

In this case, a former manager of an LLC sought advancement for fees incurred in connection with defending a claim by his former employer. His employment agreement and the LLC agreement both contained nearly identical language providing for the right to advancement. The company attempted to defeat the advancement claim by alleging that the manager who was seeking advancement procured his position by fraud and that the agreements providing for advancement were based on fraudulent inducement. The court acknowledged the Delaware LLC Act’s analogue to DGCL section 145.

The court found that the company’s defenses were based on plenary claims. This opinion affirmed the Court of Chancery’s decision to prevent such plenary claims from impeding the prompt resolution of the advancement claim for several reasons. First, whether the allegations of fraud were ultimately successful was an issue to address in connection with indemnification in a separate and subsequent proceeding. Whether indemnification was appropriate was not a defense to advancement in the interim. Second, the court explained that a party cannot escape an otherwise valid contractual provision by arguing that the underlying contract was fraudulently induced or invalid for some reason unrelated to that provision. In addition, the court emphasized that advancement proceedings are summary in nature, and Delaware courts do not countenance attempts to delay the proceedings by addressing plenary claims.

A recent Chancery decision is notable partly because it falls within the minority of advancement cases that deny advancement of fees to a former employee who was given the title of vice president. Its application may be limited due to procedural quirks and its reliance on New Jersey law. In Aleynikov v. The Goldman Sachs Group, Inc., C.A. No. 10636-VCL, Order and Final Judgment (Del. Ch., July 13, 2016), the Court of Chancery’s post-trial decision features an unusual result in that a vice president was denied advancement, but the 17-page Order of the court was based primarily on the doctrine of “issue preclusion”, and in particular how that concept was construed under New Jersey case law. Thus, it may not be of widespread usefulness in other Delaware corporate litigation regarding advancement.

The Court of Chancery also explained why it disagreed with an analysis of the doctrine of contra proferentem as applied by the U.S. Court of Appeals for the Third Circuit, but nonetheless felt constrained by its decision based on the doctrine of issue preclusion. Notwithstanding its obligation to follow that prior ruling, for much of the 17-pages of the Order, the Court of Chancery explained why it disagreed with the Third Circuit and why it would have reached a different conclusion. This case is now on appeal before the Delaware Supreme Court.

This case should be compared to another recent decision which also shares the uncommon result of denying advancement to someone with the title of an officer. See Pulier v. Computer Sciences Corp., highlighted on these pages. That separate case was also impacted by the application of another state’s law.

Procedural History

The procedural history of this case is somewhat tortuous. Initially, the United States District Court for the District of New Jersey granted summary judgment in favor of Aleynikov on the advancement issue, but on appeal, the United States Court of Appeals for the Third Circuit reversed and vacated the trial court’s ruling. Aleynikov then filed the instant action in Delaware seeking an interpretation of his rights under Delaware law. On April 28, 2016, the Court of Chancery held a one-day trial.

Useful Aspects of Decision

Based on the finding that the court was bound by a prior ruling of another court, which in turn was based on New Jersey law, this Order has limited application, and that is one reason the court likely explained its 17-page decision in the form of an Order, as opposed to a formal opinion. Nonetheless, the Court’s discussion of the doctrine of contra proferentem, as well as the concept of in pari materia when interpreting the bylaws of a parent company and the different bylaws of its subsidiaries, could have useful application. Also useful is the truism observed by the court that corporations have the authority to extend the benefits of advancement not only to officers but also to all employees and agents of a company. See DGCL Section 145(e).

Compare Recent Similar Holding

This case should be compared to another recent Chancery decision in a separate matter that also reached the unusual conclusion of not awarding advancement; and that case was also based on non-Delaware law and the constrained interpretation of the word “officer” under Nevada law and Nevada bylaws. See Pulier v. Computer Sciences Corp., et al., C.A. No. 12005-CV (transcript) (Del. Ch. May 12, 2016), as highlighted on these pages here.

 

Narayanan v. Sutherland Global Holdings Inc., C.A. No. 11757-VCMR (Del. Ch. July 5, 2016). This Delaware Court of Chancery opinion addressed: (1) Whether separate sources of indemnification, including the company’s bylaws and an indemnification agreement, must be read together or separately; (2) Whether the plaintiff-director served the entity at the request of the company or for his own personal benefit; and (3) Whether the court should delay granting the request for fees, and fees-on-fees, until after the court determines that the company is liable for those fees. Each of the issues was decided in favor of the plaintiff-director.

Brief Overview:

Although Delaware entities were involved, many of the activities giving rise to this case occurred in India. One of the developments that precipitated the litigation by the plaintiff-director, is that upon his retirement, the company did not honor its alleged obligation to buy his shares. The plaintiff-director took legal action to obtain payment for his shares. The initial action was filed in federal court in New York and the Company filed counterclaims. The Company also filed a criminal complaint against the plaintiff-director in India alleging breach of duties.

Basis for Advancement:

The three instruments on which the claims for advancement are based are: (1) The certificate of incorporation; (2) bylaws, and (3) indemnification agreement. After making a demand and attaching an undertaking, the complaint in this matter was filed on November 30, 2015. It is noteworthy that the trial was held within 70-days after the complaint was filed, and this 44-page opinion was issued promptly thereafter.

Holdings:

(1) The court held that the bylaws are a separate and independent source of indemnification and advancement that do not require cooperation even though other documents might have that as a condition; (2) The controller of the company requested that the plaintiff-director serve in both entities involved in this matter and that satisfied any prerequisites for advancement; and (3) There is no further reason to delay vindicating the right to advancement notwithstanding other issues that have yet to be adjudicated.

Legal Analysis:

DGCL Section 145 governs the advancement issues in this case. The court observed the truism that a corporation has discretionary authority to provide indemnification under subsections (a) and (b), as well as advancement under subsection (e), but must provide indemnification in certain circumstances pursuant to subsection (c).

Section 145(f) makes clear that the indemnification and advancement rights under the DGCL are not exclusive of any additional indemnification and advancement rights a corporation chooses to provide in a separate instrument. The court cited to other recent decisions in which the court recognized that there could be several separate and independent sources of advancement. See Marino v. Patriot Rail Company, 131 A.3d 325, 332 (Del. Ch. 2016), highlighted on these pages here, as well as Charney v. American Apparel, Inc., 2015 WL 5313769 (Del. Ch. Sept. 11, 2015), highlighted on these pages here. Charney stands for the proposition that unavailability of advancement under one source of rights does not foreclose the possibility of advancement under another.

Exception to Rule that Multiple Contracts Construed Together

The court addressed the principle that when multiple contracts are signed together as part of a single transaction, those contracts are often interpreted together, apart from any explicit incorporation by reference. Namely:

“The principle that all writings which are part of the same transaction are interpreted together also finds application in the situation where incorporation by reference of another document may be inferred from the context in which the documents in question were executed,” in the absence of any contrary intention. See Slip Op. at 29 and n.77 (citing 11 Williston on Contracts § 30:26 (4th ed. 1999)).

Notwithstanding the foregoing principle, the court emphasized the exception to the rule which is “in the absence of evidence to the contrary,” which applies in this case. Compare a very recent advancement decision in Aleynikov v. The Goldman Sachs Group, Inc., highlighted on these pages, in which the Court of Chancery discussed the doctrine of in pari materia, in connection with reading the separate bylaws of a parent company and its subsidiary in a consistent manner.

After reciting the basic principles of contract interpretation, the court held that under the circumstances present, the bylaws and the separate indemnification agreement were independent sources of advancement rights. The court found that based on the testimony and evidence at trial, that the plaintiff-director served at the request of the person who was the controlling stockholder, chairman and CEO – – which the court viewed as tantamount to a request by the corporation. That controlling stockholder, chairman and CEO had apparent and actual authority to direct employees and to bind the company. Therefore, that fact satisfied the requirement in the bylaws that the company request plaintiff-director to serve in his capacity.

A Determination on Exact Amount of Fees:

The court expressed the view oftentimes repeated in recent advancement decisions that a proceeding to determine the right to advancement is not the appropriate time to dispute the precise amount of fees, and that in an advancement proceeding, the court will not inject itself as a “monthly monitor of the precision and integrity of advancement requests.” See footnote 93.

In addition, the court was satisfied that plaintiff-director’s counsel segregated as best as possible the unrecoverable fees from his affirmative claims in New York as compared to the defense of the counterclaims which were subject to advancement.

Procedure for Payments Going Forward:

The court imposed an order requiring that the parties follow the framework and procedures for monthly requests for fees, and any disputes of same, detailed by the court in the case of Danenberg v. Fitracks, Inc., 58 A.3d 991, 1003-04 (Del. Ch. 2012).