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Noteworthy 2011 Corporate and Commercial Decisions from Delaware’s Supreme Court and Court of Chancery.

By:  Francis G.X. Pileggi and Kevin F. Brady.

Introduction

This is the seventh year that we are providing an annual review of key Delaware corporate and commercial decisions. During 2011, we reviewed and summarized approximately 200 decisions from Delaware’s Supreme Court and Court of Chancery on corporate and commercial issues.  Among the decisions with the most far-reaching application and importance during 2011 include those that we are highlighting in this short overview.  We are providing links to the more complete blog summaries, and the actual court rulings, for each of the cases that we highlight below. Prior annual summaries are linked in the right margin of this blog.

Top Five Cases from 2011

We begin with the Top Five Cases on corporate and commercial law from Delaware for 2011 and we are glad to see that at least four of them have some support from the bench as these were the cases that four Vice Chancellors highlighted as important decisions in a recent panel presentation that they offered in New York City in early November 2011.  Those cases were the following:  In Re: OPENLANE Shareholders Litigation; In Re: Smurfit Stone Container Corp. Shareholder Litigation; In Re: Southern Peru Copper Corp. Shareholder Litigation and Air Products and Chemicals, Inc. v. Airgas Inc., and Kahn v. Kolberg Kravis Roberts & Co., L.P.

In Re: OPENLANE Shareholders Litigation. In what many commentators referred to as a “sign and consent” transaction, in which the majority shareholders and the board of directors had sufficient control to provide the statutorily required consent, the Court of Chancery determined that the Revlon standard was satisfied and fiduciary duties were not breached notwithstanding the Omnicare case and even without customary safeguards such as a fairness opinion. See fuller summary here.

 In Re: Smurfit Stone Container Corp. Shareholder Litigation. The Court of Chancery denied a motion for preliminary injunction and determined that the Revlon standard applied to a merger for which the consideration was split roughly evenly between cash and stock. See fuller summary here.

In Re: Southern Peru Copper Corp. Shareholder Litigation. In what may be the largest award granted in the Court of Chancery’s venerable history, a judgment was entered for $1.2 billion (later amended to $1.3 billion) for breach of fiduciary duties in connection with an interested transaction. With interest, the total is expected to be $2 billion.  The Court later awarded attorneys’ fees of 15% which amounts to $300 million, in this derivative action. See fuller summary here.

Air Products and Chemicals, Inc. v. Airgas Inc. This magnum opus of over 150-pages in length will be the focus of scholarly analysis for many years to come. For purposes of this short blurb, it ended a year-long takeover battle between two determined companies, with the Court of Chancery ruling, among other things, that the target company was not required to pull its poison pill when the board determined that the offer for the company was too low. See fuller summary here.

Kahn v. Kolberg Kravis Roberts & Co., L.P.  This Delaware Supreme Court decision reversed and remanded an opinion by the Court of Chancery interpreting “a Brophy claim as explained in Pfeiffer.”  The issue before the Court was whether a stockholder had to show that the company had suffered actual harm before  bringing  a breach of loyalty claim that a fiduciary improperly used the company’s material, non-public information (a Brophy claim).  The Supreme Court rejected that part of the Chancery’s decision in Pfeiffer v. Toll which requires a showing of actual harm to the company.  See fuller summary here.

We also selected the following additional noteworthy cases:

Shareholder Litigation

In Re: John Q. Hammons Hotels, Inc. Shareholder Litigation.  Despite the application of the entire fairness standard, the Court concluded that the merger price was entirely fair, the process leading to the transaction was fair, that there was no breach of fiduciary duty, and therefore no claims for aiding and abetting fiduciary duty.  See fuller summary here.

Reis v. Hazelett Strip-Casting Corp.  The Court applied an entire fairness analysis and held that the attempt to cash out minority shareholders via a reverse split was neither the result of a fair process nor did it involve a fair price.  See fuller summary here.

In re: Del Monte Foods Co. Shareholders Litigation. This first of three rulings enjoined a shareholder vote on a premium LBO transaction and the buyers’ deal protection devices.  The Court also held that the advice that the target board received from a financial advisor (who also did work on the deal for the bidder) was so conflicted as to give rise to a likelihood of a breach of fiduciary duty and the Court indicated that the financial advisory firm could face monetary damages due to aiding and abetting the potential breach.  See fuller summary here.

In re: Massey Energy Company Derivative and Class Action Litigation.  The Court declined to enjoin a proposed merger.  The Court noted that the derivative claims that the plaintiffs argued were not being fairly valued as part of the merger, would become assets of the surviving corporation.  The Court reasoned in part that the shareholders should decide for themselves whether to exchange their status as Massey stockholders for a chance to receive value from a third party in an arms-length merger.  See fuller summary here.

Frank v. Elgamal.  This decision exemplifies the different approach taken by different members of the Court in connection with an application for interim fees in a class action.  (Compare the different approach in the Del Monte case.)  See fuller summary here.

Krieger v. Wesco Financial Corp.  This decision determined that holders of common stock were not entitled to appraisal rights under Section 262 when they had the option of electing to receive consideration in the form of publicly traded shares of the acquiring company.  See fuller summary here.

In re: The Goldman Sachs Group, Inc. Shareholder Litigation.  In this first corporate opinion by Vice Chancellor Glasscock, the Court dismissed a derivative action brought against Goldman’s current and former directors based on a failure to make a pre-suit demand.  At issue was Goldman’s allegedly excessive compensation structure.  See fuller summary here.

Contested Director Elections

Genger v. TR Investors, LLC.  In this opinion, the Delaware Supreme Court addresses electronic discovery issues and contested elections for directors involving DGCL Section 225. See fuller summary here.

Johnston v. Pedersen.  This opinion determined that directors breached their fiduciary duties when issuing additional stock and as a result were not entitled to vote in connection with the removal of the incumbent board and the election of the new directors.  See fuller summary here.

Section 220 Cases

King v. VeriFone Holdings, Inc. This Delaware Supreme Court ruling reversed a Chancery decision that found a lack of proper purpose in a suit by a shareholder seeking books and records pursuant to Section 220.  Delaware’s High Court explained that it remains preferable to file Section 220 suits for books and records prior to filing a derivative suit, but holding that such a chronology is not, per se, a fatal flaw in a Section 220 action.  See fuller summary here.

Espinoza v. Hewlett Packard Co. This affirmance of Chancery’s denial of a §220 claim was based on the requested report to the board being protected by the attorney/client privilege.  (This is one of several decisions in this matter.) See fuller summary here.

Graulich v. Dell., Inc.  This is a Section 220 case in which Chancery denied a request for books and records due to the underlying claims being barred by a previous release and due to the shareholder not owning the shares during the period of time for which he was requesting documents.  See fuller summary here.

Alternative Entity Cases

CML V, LLC v. Bax.  This Delaware Supreme Court decision determined that creditors of an insolvent LLC are not given standing by the Delaware LLC Act to pursue derivative claims unlike the analogous situation in the corporate context.  See fuller summary here.

Sanders v. Ohmite Holding, LLC.  This decision clarified the rights of a member of an LLC that demanded books and records of an LLC.  The Court determined that pursuant to Section 18-305 of the Delaware LLC Act a member may seek records for a period prior to becoming a member of the LLC.  See fuller summary here.

Achaian, Inc. v. Leemon Family LLC.  This opinion addressed the transferability of interests of a member of an LLC and specifically whether one member of a Delaware LLC may assign its entire membership interests, including voting rights, to another existing member, notwithstanding the provision in an agreement that requires the consent of all members upon the admission of a new member.  See fuller summary here.

Jurisdictional or Procedural Issues

Central Mortgage Co. v. Morgan Stanley Mortgage Capital Holdings LLC.  In this decision, a Delaware Supreme Court determined that Delaware would not follow the standards for a motion to dismiss under Rule 12(b)(6) announced by the U.S. Supreme Court in the Twombly or Iqbal opinions.  See fuller summary here.

Hamilton Partners, LP v. Englard.  This decision addressed the issue of personal jurisdiction over directors and interlocking entities, as well as demand futility in the context of a double derivative shareholders suit.  (Although this was decided at the end of 2010, it was important enough to include in this list as it was issued after our deadline for our compilation last year). See fuller summary here.

Encite LLC v. Soni.  This decision rejected a request for an extension of a deadline for submitting expert reports because the Court did not approve an amendment to the Scheduling Order.  See fuller summary here.

Whittington v. Dragon Group.  In this latest iteration of multiple decisions in this long-running saga, the Court examines the doctrine of claim preclusion, issue preclusion and judicial estoppel.  See fuller summary here.

In re: K-Sea Transportation Partners, L.P. Unitholders Litigation.  This decision provides a useful recitation of the standard used in Chancery for deciding whether to grant a motion to expedite proceedings, and it also reviews language in a limited partnership agreement which arguably was an effective waiver of traditional fiduciary duties as allowed by the LP statute.  See fuller summary here.

Sagarra Inversiones, S.L. v. Cemento Portland Valderrivas, S.A.  This ruling determined that the standard of “irreparable harm” granting injunctive relief was not satisfied based on the financial condition of the defendant which was “not poor enough” to convince the Court that a money judgment would not make the plaintiff whole.  (This is one of several decisions in this matter.) See fuller summary here.

ASDC Holdings LLC v. The Richard J. Malauf 2008 All Smiles Grantor Retained Annuity Trust.  This decision discussed the enforceability of forum selection clauses and in particular when those clauses will be enforced despite a related case being filed first in another forum.  See fuller summary here.

Gerber v. ECE Holdings LLC.  This decision discusses the difference between a motion to supplement and a motion to amend a complaint.  See fuller summary here.

Advancement

Fuhlendorf v. Isilon Systems, Inc.  This decision addresses the advancement of fees incurred by officers and directors sued in connection with their corporate roles.  The specific issue in this case was whether the corporation should pay for all of the costs of a Special Master appointed to review the interim application for fees.  The case also discusses the common procedure employed to review disputed monthly legal bills in advancement cases.  See fuller summary here.

Receiver or Dissolution

Pope Investments LLC v. Benda Pharmaceutical Inc.  This decision rejected the application for the appointment of a receiver on the grounds that while the plaintiff demonstrated that the defendant was insolvent, the plaintiff failed to show that “special circumstances existed which would warrant the appointment of a receiver.”  See fuller summary here.

Stephen Mizel Roth IRA v. Laurus U.S. Fund, L.P.  This decision rejected a request to dissolve a limited partnership and refused to appoint a receiver in the context of an investment fund that was in liquidation mode but was not dissolved, nor was it winding-up as that term is used in the statute.  See fuller summary here.

Legal Ethics

BAE Systems Information and Electronics Systems Integration, Inc. v. Lockheed Martin Corp.  This opinion addresses Delaware Lawyers’ Rule of Professional Conduct 3.4(b) and discusses those situations in which a fact witness may be compensated for the “lost time” away from his “day job” suffered while testifying.  See fuller summary here.

Judy v. Preferred Communications Systems, Inc.  This decision addresses the issue of legal ethics involved in determining whether an attorney may assert a retaining lien over the documents of a former or delinquent client.   See fuller summary here.

Common Law v. Statutory Claims

Overdrive, Inc. v. Baker & Taylor, Inc.  In this last formal decision  by Chancellor Chandler, the Court discussed how the Delaware Uniform Trade Secrets Act displaces conflicting tort and other common law claims that are grounded in the same facts which would support the statutory misappropriation of trade secret claims.  See fuller summary here.

Damages for Breach of Agreement to Negotiate in Good Faith

PharmAthene, Inc. v. SIGA Technologies, Inc. This Court of Chancery decision awarded damages for breach of a contractual obligation to negotiate in good faith and fashioned an equitable remedy that required the sharing of profits from the production of a product that the defendant failed to negotiate the license of in good faith. There are several decisions involving contract law by the Court of Chancery in this matter, the most recent ruling denying a motion for reargument. See fuller summary of the most recent decision here.

Postscript

On a final note, the last week of 2011 saw the sudden and sad passing of one of the nation’s foremost experts on alternative entities, Professor Larry Ribstein, who was often cited in opinions of the Delaware Courts. He coined the word “uncorporations” to refer to alternative entities and was the author of many treatises, law review articles and other publications on uncorporations, jurisdictional competition, the business of law firms and related topics involving the intersections of law and business. He was an iconic figure in the law, and the legal profession is better because of his many contributions.

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UPDATE: The Harvard Law School Corporate Governance Blog published this post here. The NACD’s Directorship.com site kindly published this article as a lead story on Jan. 5, 2012, available here. Professor Stephen Bainbridge graciously commented on this summary in his post available here. Professor Joshua Fershee on the Business Law Prof  Blog linked to this summary with kind references here.

In Baker v. Impact Holdings, Inc., C.A. No. 5144-VCP (Del. Ch., July 30, 2010), read opinion here, the Court of Chancery granted a motion to dismiss an action for advancement for litigation expenses incurred in two prior preemptive and affirmative actions filed by the petitioner, Baker. Baker argued that he was entitled to mandatory advancement because he claimed that he brought the actions “in defense of” allegations made and actions taken by Respondent Impact following what Baker characterized as an investigation into his performance as a director and officer of Impact. See highlights of prior Chancery decision in this case here.

This summary was prepared by Kevin F. Brady of Connolly Bove Lodge & Hutz LLP.

In January 2008, Impact purchased stock in two entities beneficially owned by Baker, and as a result of this sale, Baker became an officer and director of Impact. Impact later took ownership of Impact Confections, Inc. and asked Baker to serve as an officer and director of Confections. Subsequent to the Confections’ acquisition, Impact initiated a financial audit at Confections that allegedly led to an investigation into Baker’s performance as an officer and director of Impact and Confections. Allegedly as a result of that investigation, Impact removed Baker as a director of Impact. After his removal, Baker initiated several actions including an action seeking advancement of his fees and expenses incurred in the other actions.

In a counterclaim filed in one of the actions, Impact alleged that Baker breached his fiduciary duties to Impact and Confections. Importantly for this motion, Impact did not assert any claims against Baker for these alleged breaches. Baker claimed that Impact’s allegations arose as a result of Impact’s internal investigation, and that he filed those actions “to defend against” the effect of the investigation which was “his removal as a director of Impact and the damage to his reputation caused by Impact’s accusations.”

In its analysis, the Court examined Article VIII of Impact’s Certificate of Incorporation which governed indemnification and advancement and mandated advancement as follows:

[Impact] shall indemnify any person who was, is, or is threatened to be made a party to a proceeding (as hereinafter defined) by reason of the fact that he or she (i) is or was a director or officer of [Impact] or (ii) while a director or officer of [Impact], is or was serving at the request of [Impact] as a director, officer… or similar functionary of another foreign or domestic corporation…or other enterprise, to the fullest extent permitted under the Delaware General Corporation Law, as the same exists or may hereafter be amended…Such right shall include the right to be paid by [Impact] expenses (including without limitation attorneys’ fees) actually and reasonably incurred by him in defending any such proceeding in advance of its final disposition to the maximum extent permitted under the Delaware General Corporation Law, [DGCL] as the same exists or may hereafter be amended.

It is also important for this motion that the Court noted that Article VIII broadly defined a “proceeding” as “any threatened, pending, or completed action, suit, or proceeding, whether civil, criminal, administrative, arbitrative, or investigative, any appeal in such an action, suit, or proceeding, [or] any inquiry or investigation that could lead to such an action, suit, or proceeding.”

On October 12, 2009, Baker sent a letter to Impact demanding advancement for fees and expenses incurred in connection with the actions he filed. After Impact refused that demand, Baker filed his petition.

Parties’ Contentions

Impact moved to dismiss arguing that, among other things: (i) the petition did not sufficiently show how that investigation (audit of Confection’s financial records) constituted a “proceeding;” and (ii) the actions were not “in defense of” an action, but in fact were affirmatively filed by Baker not to defend against any proceeding, but “to preemptively ameliorate certain negative effects he claims resulted from the Investigation.” Baker responded that: (i) the investigation constituted a “proceeding” under the expansive definition in the Certificate because Impact used information gained during the investigation to support its allegations in the counterclaim that Baker breached his fiduciary duties and as the basis for removing him as a director of Impact; and (ii) he filed the actions to defend himself from the allegations in and results of the purported investigation.

Baker Entitled to Advancement for Affirmative Litigation

DGCL § 145(e) grants a corporation authority to advance expenses, including attorneys’ fees incurred “in defending” a covered proceeding, to a director or officer. Section 145(e) provides only that a corporation “may” pay the defensive expenses of its directors, officers, or employees in advance of the final disposition of a covered proceeding. However, corporations frequently “make the right to advancement of expenses mandatory, through a provision in its certificate or bylaws or…a contract specifically addressing the issue.”

To determine whether a director has such a mandatory right, the Court examined the language of the Certificate finding “unambiguous language” of the advancement provision. As a result, the Court found that even though Baker had alleged facts sufficient to show that Impact’s investigation may fit within the definition of a “proceeding,” he did not bring the actions “in defense of” that investigation.”

The Investigation Was a “Proceeding”

Based upon what Impact alleged in its Counterclaim concerning various actions and omissions by Baker purportedly revealed by the investigation, and, specifically, its characterization of the Investigation, the Court rejected Baker’s contention that Impact conducted an internal investigation specifically into his conduct as a director of Impact or Confections. Rather, the Court found that the investigation referred to in the Counterclaim appeared to be primarily an audit of Confections’ financial records that “happened to lead, as an understandable by-product, to the accusations about which Baker complains.”

However, the Court did not dismiss the claim because of the broad definition of “proceeding” in the Certificate. The Court noted that “the language of that definition seems broad enough to encompass, at its widest point, even a threatened inquiry that could lead to an action, suit, or formal proceeding against Baker. Under this expansive designation, it is conceivable that the financial audit of Confections could constitute an inquiry…that could lead to such an action, suit, or proceeding against Baker, including a possible further investigation specifically into his conduct as a director.” As a result the Court found that Baker had sufficiently alleged the existence of a “proceeding” under the Certificate.

The Actions Were Not Brought “In Defense Of” the Investigation

The advancement provision expressly limited advancement to expenses incurred by a covered person “in defending” a proceeding to which that person “was, is, or is threatened to be made a party.” The Court referenced Citadel Holding v. Roven, 603 A.2d 818, 824 (Del. 1991), where the Delaware Supreme Court found that, “in addition to expenses normally incurred in the context of litigation naming a covered person as a defendant, i.e., attorneys’ fees accrued while defending that litigation, the “in defending” language also applies to: (1) a covered person’s affirmative defenses and (2) compulsory counterclaims directly responding to and negating an affirmative claim against that person…” In this action, however, the Court found that because Impact had not asserted any claims against Baker, he could not reasonably argue that the actions he filed directly relate to and negate claims since no claims were raised.
 

Professor Larry Ribstein has a thoughtful analysis here of an issue that is attracting increasing attention: Why are Delaware governance issues being litigated in courts other than in Delaware? In particular he refers to the recent Delaware Court of Chancery decision in Baker v. Impact Holding, Inc., which we highlighted here, as well as academic writings on the topic. We have written about this topic on these pages in the past and I suspect we will hear more about this matter anon.

In Schoon v. Smith, (Del. Supr., Feb. 12, 2008), read opinion here, the Delaware Supreme Court ruled yesterday that a director qua director may not sue fellow directors of a corporation derivatively. This may sound esoteric for some, but any time the Delaware Supreme Court decides an issue that relates to the duties and/or rights of directors of a Delaware corporation, most serious students of corporate law and Delaware litigation pull up their socks and pay attention. Three prior decisions by the Chancery Court regarding litigation between (at least some of) the parties in this case were summarized here, here and here. 

 Fortunately for me, we have the benefit of a prompt and insightful comment on the case here, that comes to us courtesy of Steven M. Haas of Hunton and Williams LLP via the Harvard Corporate Governance Law Blog.

Does a Director Qua Director Have Standing to Sue Derivatively? No, so said the Delaware Supreme Court yesterday in Schoon v. Smith. The Supreme Court affirmed the Court of Chancery’s little-noticed ruling last year that dismissed a derivative claim brought by a director against the company’s other directors, including its controlling stockholder. The plaintiff-director, who was not a stockholder of the company, charged his fellow directors with, among other things, breach of fiduciary duty and unjust enrichment. The court held that, notwithstanding the equitable origins of derivative suits, the issue of director standing today is best left to the legislature. “Although the Delaware General Assembly has the prerogative to confer standing upon directors by statute,” the court wrote, “it has not chosen to do so.” Rejecting the American Law Institute Principles that give individual directors standing to sue on behalf of their corporations, the court continued that, “[b]ecause a stockholder derivative action is available to redress any breach of fiduciary duty, we decline to extend the doctrine of equitable standing to allow a director to bring a similar action.” The court concluded, however, by leaving itself a little room to permit directors to bring derivative suits, but only where the failure to do so would result in a “complete failure of justice”—a seemingly high standard.

As a practical matter, the decision is unlikely to have much significance because most directors are also stockholders. But the decision is still significant and may draw criticism with respect to its implications for corporate governance and director duties. In particular, the court noted that the concept of being an “independent director” does not mandate “a duty to sue on behalf of the corporation.”

UPDATE: Here is a post on the case by Professor Bainbridge who was kind enough to link to this post but more importantly he provides a prescient excerpt from his treatise on Corporation Law and Economics that addresses the same issue decided by the court in this opinion.

 

Here is a post from the Delaware Business Litigation Report that flags a recent decision from the U.S. District Court for the District of Delaware which found personal jurisdiction based on aspects of a transaction that created ties to Delaware.  See G & G LLC v. White. Read opinion here. The post included the following summary:

Plaintiff pointed to numerous instances where the Utah corporation, the Delaware corporation, their counsel, the directors/officers of the Delaware corporation (who were appointed by the investor defendants), and the investor defendants failed to notify Plaintiff of the merger and/or made misrepresentations regarding the continuing status of the corporation as a Utah corporation. Taking the allegations as true, the Court found that the actions of the investor defendants and the directors they appointed was sufficient to confer specific jurisdiction over them.

The opinion discusses the application of the Delaware long-arm statute in the context of both general and specific jurisdiction and cites to the many federal decisions in Delaware that have applied the statute. Interestingly, the opinion does not cite to the recent Chancery Court opinion that  found personal jurisdiction based on the actions of an outside attorney of a corporation in connection with aspects of a transaction that created ties to Delaware. See Sample v. Morgan summarized here.

Notably,  however, the District Court  did cite to the recent Troy Corp. v. Schoon Chancery decision, summarized here, that also dealt with a forum selection clause that was not artfully drafted. In particular, even though one of the clauses quoted by the court gave exclusive jurisdiction to the Delaware Chancery Court, the District Court for the District of Delaware could not rely of that provision to impose jurisdiction in federal court simply because it was also in Delaware.