The 35th Annual Francis G. Pileggi Distinguished Lecture in Law (named after the father of this blog’s primary author) will be held on:

Friday, November 8, 2019.

Registration and breakfast is at 8:00 a.m. at the Hotel du Pont in Wilmington, Delaware. The Annual Lecture begins at 8:45 a.m.

Download the brochure which also provides details for registration online. The law school’s summary of the event is available on their website.

Prior Annual Pileggi Lectures have been highlighted on these pages.

The Delaware Journal of Corporate Law at Delaware Law School, which handles the administrative aspects of this annual event, provides more information about prior speakers in the series on their website.

A recent Chancery decision is notable for its application of the implied covenant of good faith and fair dealing in a partnership agreement that waives all conventional fiduciary duties, and replaces them with a contract-based standard of conduct. The decision in Bandera Master Funds LP v. Boardwalk Pipeline Partners, LP, C.A. No. 2018-0372-JTL (Del. Ch. Oct. 7, 2019), is an exemplary exegesis of standards and nuances and subtleties that must be addressed before finding a breach of the implied covenant of good faith and fair dealing–especially when conventional default fiduciary duties in the alternative entity context are waived. See Slip op. at 46-48.

Why this case is notable: This case provides a cornucopia of “first principles” of Delaware corporate law in several footnotes. See, e.g., footnotes 5-9 and accompanying text.

For example, the court observes that in for-profit entities, fiduciary duties are owed to all stockholders–and the court describes those increasingly important instances where consideration of other constituencies and factors may be consistent with that primary focus of fiduciaries, i.e., the shareholder wealth maximization norm. See Slip op. at 30-31 and n.8.

This decision is also worthy of attention because it finds a difficult-to-prove breach of the implied covenant of good faith and fair dealing. The court explains why, based on the facts presented, it is “reasonably conceivable” that the implied covenant was breached. See Slip op. at 48-49.  The court also reasoned that it was not surprising that there was no express term that barred manipulation of a “call price.”

UPDATE: The venerable Professor Bainbridge, a nationally-prominent corporate law professor, often cited by Delaware courts, graciously linked to this post on his blog.

This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications, for over 30 years.

A shareholder who made a veiled threat to take action against a biopharmaceutical company over its directors’ allegedly excessive compensation effectively made a pre-suit demand and cannot later sue and claim that a demand would have been futile, the Delaware Chancery Court has ruled in Solak v. Welch, et al., No. 2018-0810 KSJM, memorandum opinion (Del. Ch. Oct. 30, 2019).

 Vice Chancellor Kathaleen St. Jude McCormick’s October 30 opinion dismissed John Solak’s derivative suit against Ultragenyx Pharmaceutical Inc.’s directors, finding that his pre-suit letter requesting them to address non-employee board member compensation was not a harmless investor request.  Rather, it was a “proverbial wolf in sheep’s clothing” demand “with far more legal bite” that required the plaintiff to either prove the directors wrongfully refused to take action or suffer the court’s dismissal of his breach of duty and waste of assets charges, the vice chancellor said.

Only two choices

She said the Delaware Supreme Court’s Spiegel v. Buntrock decision gives investors seeking to sue in the name of the company two choices: either first demand that the directors, as managers of the company, take action to right a wrong or skip the demand and show that it would have been futile because the directors are too conflicted to give the charges a fair review. Spiegel v. Buntrock 571 A.2d 767, 772-73 (Del 1990).

The vice chancellor’s opinion says Spiegel does not allow a shareholder to demand an action under the guise of  seeking better corporate governance practices and then use the second Buntrock option and argue that his letter was not a pre-suit demand but rather “an informal, good faith attempt to educate the board and encourage it to make changes.”

According to Vice Chancellor McCormick’s opinion, Solak’s counsel sent a June 2018 letter to the Novato, Calif. company’s directors suggesting that they correct the excessive $400,000 a year average compensation the independent directors have been receiving since 2014.

The letter claimed that pay plan lacks meaningful limitations and renders the company “more susceptible than ever to shareholder challenges and that Solak would consider “all available shareholder remedies” unless Ultragenyx responded in thirty days.

When the board rejected the request the following October after an internal investigation of compensation policies, Solak sued in Chancery Court one month later and the directors moved to dismiss it in December for failure to show that plaintiff’s pre-suit demand was improperly refused.

The ‘steeper’ route

After hearing oral argument on the motion in August, the vice chancellor said the pivotal issue was whether Solak’s letter constituted a pre-suit demand.  That’s because of the two Spiegel options for a derivative plaintiff, successfully pleading that pre-suit demand would have been futile because of director conflict was a “steep” route, he said; but proving that his demand was wrongly refused was “steeper yet.”

In light of the Spiegel court’s holding that a plaintiff who makes a pre-suit demand “tacitly concedes” that the board is qualified to consider that demand under the protective business judgment rule, Solak argued that the letter was not a pre-suit demand.

The judge said under Delaware caselaw, a pre-suit letter is a demand if it provides, “(1) the identity of the alleged wrongdoing, (2) the wrongdoing allegedly perpetrated and the resultant injury to the corporation and (3) the legal action the shareholder wants the board to take.”

Demand disclaimer

She said the disclaimer in Solak’s letter that it could not be construed as a pre-suit demand does not shield it from the Delaware law prohibition against both making a pre-suit demand and pleading demand futility “to cover all the bases.”

The vice chancellor also rejected Solak’s argument that his letter was not a demand because it did not expressly demand that the directors commence litigation. She said previous Chancery Court decisions have found that clearly demanding corporate action is sufficient.

Moreover, Solak’s letter “reads like a complaint” and is “nearly a carbon copy” of his later-filed lawsuit in drawing comparisons with compensation levels at other companies and in the remedial measures it requests, the opinion says.

In addressing Solak’s argument that shareholders will be deterred from even ambiguous communications that might be considered a demand, making a subsequent derivative suit procedurally more difficult, the vice chancellor said normally, the investor’s ambiguity would get the benefit of the doubt.

Similar suit, same result

However, she noted a 2018 New York state court decision dismissing a suit by Solak after he made what constituted a pre-suit demand for action by another corporation’s board to correct alleged excessive director compensation. Solak v. Fundaro, Index No. 655205/2017, slip opinion (N.Y. Sup. Ct. Mar. 19, 2018).

She said in that New York case, Solak unsuccessfully attempted to “dress down” the pre-suit communication. “The product of this tactical wordsmithing is not the sort of “ambiguity” warranting a plaintiff-friendly presumption.”

Applying the business judgment rule, the vice chancellor found no reason to doubt the good faith of the directors’ decision to refuse the pre-suit demand and dismissed Solak’s suit.

A recent Delaware Court of Chancery decision interpreted an ambiguous LLC agreement that it described–at least “at first read”–as “confusing and internally inconsistent.” The decision in MKE Holdings Ltd. v. Schwartz, C.A. No. 2018-0729-SG (Del. Ch. Sept. 26, 2019), in addition to being a helpful analysis for purposes of providing an insight into how the court analyzes an agreement that is not self-explanatory, will remain noteworthy because its introductory paragraph should be required reading for any lawyer who drafts an LLC operating agreement.  The introduction to the referenced opinion provides as follows:

“This matter requires me to construe an LLC operating agreement. My father was an engineer.  He frequently remarked that machinery would not be so poorly designed if the designer were condemned personally to keep it operating.  I am a lawyer.  I am struck that LLC agreements would be better drafted if the drafters were compelled to litigate over them, or worse, construe them as judges.  In any event, such is the task I must undertake here.” (footnotes omitted.)

A recent Delaware Court of Chancery opinion is noteworthy for its discussion of many aspects of the law, but I intend to highlight only a few of them, including its description of the important concept known as the Step –Transaction Doctrine. In PWP XERION Holdings III LLC v. Redleaf Resources, Inc., C.A. No. 2017-0235-JTL (Del. Ch. Oct. 23, 2019), the court engaged in a thorough analysis of the issues related to the failure of a company to obtain prior written consent from a major stockholder before approving certain transactions.

Key Takeaways from this Decision

Step-Transaction Doctrine:

The doctrine “treats the steps in a series of formally separate but related transactions involving the transfer of property as a single transaction if all the steps are substantially linked. Rather than viewing each step as an isolated incident, the steps are viewed together as components of an overall plan.” See pages 31-32.

The court explained that the step-transaction doctrine applies if the component transactions meet one of three tests. First, the “end result test” will allow the doctrine to be invoked if it appears that a series of separate transactions were pre-arranged parts of what was a single transaction, cast from the outset to achieve the ultimate result. Id.

Second, under the interdependence test, separate transactions will be treated as one if the steps are so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series. The third and most restrictive test is the binding-commitment test under which a series of transactions are combined only if, at the time the first step is entered into, there is a binding commitment to undertake later steps. Id.

Analysis of the Terms “Affiliate” and “Business Plan.”

The court analyzed the term affiliate as it applied to a company director because consent was required for certain transactions with an affiliate of a director. See pages 17 to 21.

The court also analyzed the meaning of “business plan” because prior consent of a major stockholder was required before any changes could be made to the business plan. See pages 22 to 25.

Other Useful Statements of Delaware Principles of Law Regarding Tension between Board’s Fiduciary and Contractual Duties:

The court also discussed the concept that a board can fulfill its fiduciary duties while making a decision that (complying with those fiduciary duties) might call for engaging in “an efficient breach” of contract. See page 34.  Contrariwise, a board could comply with a contract which would result in a breach of fiduciary duty. Id.

The court also explained, in connection with a stockholder and its board-designee who took different positions on the same issue: that the rights of a stockholder, and what a stockholder might lawfully be permitted to do, are much different than the duties of a director-designee of that stockholder.  The court explained that a stockholder and its director-designee occupied:

(i) different roles;

(ii) are subject to different decisional frameworks; and

(iii) can legitimately have different views.

Other cases on these pages have addressed the duties of a “blockholder director”  who must act in the best interests of all stockholders–and not only the stockholder who appointed the director.

A recent Delaware Court of Chancery decision is noteworthy for the clarification it provides regarding several nuances of electronic discovery practice. See Ferguson v. Capital Development Insurance Company, LLC, C.A. No. 2018-0831-KSJM (Del. Ch. Oct. 8, 2019).

Key Points: Among the helpful takeaways from this short letter ruling are the following:

  • Although the Guidelines for Practitioners in the Delaware Court of Chancery suggest that the proponent of discovery should propose protocols for the recipient to use in the collection and production of ESI, the court explained that the protocol does not constitute a formal rule of court, and therefore, cannot be “weaponized” as a basis to refuse to reply to discovery requests.
  • The court observed that sometimes the person receiving discovery requests is best suited to propose ESI protocols for search, collection and production–given their superior knowledge of their data repositories, but this is not a requirement that has the force of a rule.
  • The court instructed, however, that it “encourages the proponent of discovery to propose protocols that the recipient may use when collecting electronically stored information.”

Pro Se Representation of Corporations Prohibited: In a statement of law not related to electronic discovery, the court reiterated the truism that in Delaware, entities may not appear pro se, but rather they must be represented by counsel before the court (even when it is a wholly-owned company). See Harris v. RHH P’rs, LP, 2009 WL 891810, at *2 (Del. Ch. Apr. 3, 2009).

For those readers who follow the many Chancery decisions highlighted on these pages regarding advancement for corporate officers and directors, the recent Court of Chancery decision in Nielsen v. EBTH Inc., C.A. No. 2019-0164-MTZ (Del. Ch. Sept. 30, 2019), can be added to the long line of cases that reject an argument that the requirement for advancement–that the underlying litigation was brought “by reason of the fact” of the claimant’s role as a director or officer–was not satisfied. As the court described it: “Few cases present facts that fall short of Delaware’s standard favoring advancement. This case follows the common pattern.”

An article co-authored by the undersigned, and Chauna Abner, provides a more complete overview of this case and appeared in The Delaware Business Court Insider.

This post was prepared by Frank Reynolds, who has been following Delaware corporate law, and writing about it for various legal publications,  for over 30 years.

The business judgment rule cannot shield Clovis Oncology Inc.’s directors from shareholder charges that they breached their oversight duty by ignoring reports that their flagship cancer-fighting drug was unlikely to pass regulatory tests, the Delaware Chancery Court has ruled in the matter styled: In re Clovis Oncology Inc. Derivative Litigation, No. 2017-0222-JRS, memorandum opinion (Del. Ch. October 1, 2019).

Vice Chancellor Joseph R. Slights’ Oct. 1 opinion allows the biopharmaceutical startup’s investors to proceed with derivative claims that Clovis lost $1 billion in value after the market learned that its directors failed to comply with regulatory protocol for Rociletinib.

He said duty-of-oversight charges have been among the hardest to prove, but the Clovis plaintiffs well-pled that their directors did not respond to red flags at a time when the company’s fate. depended largely on the outcome of a single lung cancer therapy trial.

A duty-of-care duo

The Clovis opinion, and the Delaware Supreme Court’s June decision in Marchland v. Barnhill, 212 A.3d 805 (Del. 2019), are being closely examined by corporate law specialists because together they provide a new avenue to sue for violating the duty of oversight.

In June, the Delaware Justices reversed a Chancery Court dismissal of a consolidated shareholder suit that charged the Blue Bell Creameries directors’ failure to oversee ice cream safety resulted in a deadly and costly listeria outbreak in 2015. The opinion, written by Chief Justice Leo E. Strine Jr., found the Blue Bell board “made no effort to put in place a board-level compliance system.”

That, he said, was a violation of the first part of the oversight duty spelled out in the seminal 1996 Caremark decision which said directors must set up and monitor systems to ensure that they get adequate information on whether the company is being operated properly. In re Caremark Int’l. Inc. Deriv. Litig. 698 A. 2d 959 (Del Ch. 1996).

Caremark duty, part two

Vice Chancellor Slights’ Clovis opinion was based on Marchand decision and focused on the second part of the Caremark duty: to properly monitor the systems the directors set up,

The plaintiffs claimed the Clovis directors in fact paid very little attention to the plan and protocol they set up for the clinical trial of Roci, an initially promising lung cancer treatment. In later stages though, there were ample indications that Roci would not get the U.S. Food & Drug Administration’s approval for market, Vice Chancellor Slights said.

The consolidated suit charged Clovis executives entered ineligible information in the clinical trial’s records that “allowed the company to mislead the market regarding the drug’s efficacy.”

The plaintiffs said when Clovis was later forced to enter the correct information, it was clear that Roci would not be approved, but some directors and a senior executive sold stock before the market learned the bad news.

In response to the defendants’ motion to dismiss, the vice chancellor said the duty to implement a proper oversight system and then monitor it is important, “especially so when a monoline company operates in a highly regulated industry.”

He noted that at the beginning of the clinical trial Clovis had no other drugs on the market, received no sales revenue and was entirely dependent on investor capital.

Business risk vs. oversight risk

Directors must have great latitude in making decisions on business risk, but “it is appropriate to distinguish the board’s oversight of the company’s management of business risk” from the board’s oversight of compliance with regulatory mandates, the judge said.

In refusing to dismiss the breach-of-duty charge he said he was satisfied that plaintiffs have properly pled that the directors “consciously ignored red flags that revealed a mission critical failure to comply” with the protocol and FDA regulations.

However, Vice Chancellor Slights dismissed an insider selling charge for lack of proof of scienter, finding that it is not enough that the sale took place near the time that the insider acquired non-public information.

This is especially true where the size of the trade is not abnormally large and does not represent a dramatic change in trading pattern, he said.

Based on the same findings, the Court also dismissed a charge that some defendants improperly enriched themselves from the insider selling.

Takeaways

Vice Chancellor Slights’ detailed recitation of what he found to be the Clovis directors’ failures to monitor and disclose Roci’s true test history could serve as a cautionary tale for a new, stricter Caremark era.

Or, turned around, it could provide proactive directors and their counsel with a to-do list for revising board-level control and disclosure.

A recent Delaware Court of Chancery opinion allowed a claim to proceed based on the theory that a termination fee for a merger agreement was not the sole remedy for breach of contract.  In Genuine Parts Co. v. Essendant, Inc., C.A. No. 2018-0730-JRS (Del. Ch. Sept. 9, 2019), the court discussed a very fact-specific, contract-based reason why the termination fee was not the sole remedy for a potentially willful breach of the merger agreement.

Key Facts:

The non-solicitation provision in the merger agreement had a “fiduciary-out” which was subject to various parameters and notice requirements.  There was also a “willful breach” exception to the termination fee as a sole remedy. 

In addition, the target-company met with another suitor before signing the merger agreement despite: (i) a representation that there were no other suitors; and (ii) no notice or disclosure of that pre-agreement meeting being made.

The claims included breach of contract because the competing bid that was accepted was allegedly not a superior bid.

Highlights of Court’s Analysis:

The court explained that non-solicitation provisions are routine, and that there is no per se prohibition about a non-solicitation provision as long as there is a “safety valve” that allows for a board to consider a superior offer. See Slip op. at 23-24, and footnotes 76-78.

The court distinguished a prior Chancery decision, which had materially different terms in the applicable agreement, where the court determined that a losing bidder was unlikely to get specific performance beyond the termination fee.  See Cirrus Holding Co. v. Cirrus Industries, Inc., 794 A.2d 1191 (Del. Ch. 2001).

By contrast, the court did follow the reasoning of another Chancery decision that found, based on the terms of the contract in that case, that a termination fee was not an exclusive remedy.  See NACCO Industries, Inc. v. Applica, Inc., 997 A.2d 1 (Del. Ch. 2009).

Recent attack ads appearing on TV that apparently were financed by a disgruntled litigant unhappy with the results of a decision by a Delaware court, generated an unusual response from the Delaware State Bar Association. A website called Town Square Delaware provides a copy of the letter. The Delaware Business Court Insider also published an article about the attack ad, in which they quoted yours truly (condemning the misguided ad.)