The latest Chancery decision in hotly contested litigation captioned In re Oxbow Carbon LLC Unitholder Litigation, Consol., C.A. No. 12447-VCL, (Del. Ch. July 28, 2017), addresses several issues that are of practical importance for all trial lawyers. Several prior Delaware decisions in this case that have been highlighted on these pages  provide additional background.  Among the key principles addresses in this decision is the application of Rule 3.7(a) of the  Delaware Lawyers’ Rule of Professional Conduct, which generally bars a lawyer from acting as an advocate at the same trial in which the lawyer is likely to be a necessary witness – – with three exceptions.  After a careful application of the rule to the facts of this case, the Delaware Court of Chancery reasoned that, on balance, the lawyer involved should not be prevented from testifying, although his testimony would be approached with care.

Court’s Analysis

The opinion explained that the lawyer involved was present during the trial but that he was not acting as an advocate to the extent that he did not have a speaking role. This was intentional because it was expected that he might be needed as a rebuttal witness.

Importantly, the court emphasized that his testimony would not undermine the fairness of the proceedings, especially because it is a bench trial and the court fully understood the difference between the role of a fact witness and the role of a counsel for one of the parties. The court provided ample citations to authority including the well-known Delaware Supreme Court decision entitled Appeal of Infotechnology, Inc., 582, A.2d 215, 221 (Del. 1990), which generally stands for the principle that a non-client litigant only has standing to enforce a rule of professional conduct such as an alleged conflict “when he or she can demonstrate that the opposing counsel’s conflict somehow prejudiced his or her rights.”  Moreover, the court is aware that rules of professional conduct are sometimes used as a tactical weapon to seek inappropriately to disqualify opposing counsel. See footnotes 22 through 24.

Trial Practice Tips from the Court

This opinion also features a practical commentary from the court with insights on trial practice regarding the order that witnesses are called, and the preference of calling a witness only once when he will be both an adverse witness and a witness favorable to the other party. The alternatives in calling an adverse witness for a party’s case in chief, involve the court deciding whether or not the party calling the adverse witness will question the party first as part of his case-in-chief.  In this case, the court decided to permit counsel to conduct a direct examination first, followed by the cross examination by the adverse party.  This approach allowed the party who has the burden of proof to determine the order of witnesses by calling adverse witnesses for its case-in-chief.  But that party here did not have the opportunity to question an adverse witness from the outset as a hostile witness.  Instead, counsel for the witness had the opportunity to present the witness first, after which opposing counsel would cross-examine.  The court preferred this approach as a more efficient use of trial time, although it deprives the party with the burden of proof of calling and questioning a hostile witness from the outset.

The author of this opinion also explained that generally he prefers to give the party with the burden of proof the ability to first question – – even an adverse witness, but in this case because both sides had asserted interrelated claims and defenses where they each technically bore the burden of proof, there was less ability to view one side as having the burden such that they should also receive the tactical advantages that accompany that burden.

Lastly, the opinion included a useful discussion of Delaware Rule of Evidence 615 regarding sequestration of witnesses and the ability of the court at the request of a party to order witnesses excluded from the trial so that they can hear the testimony of other witnesses – – with the exception of a party who was a natural person, or an officer or an employee of a party which is not a natural person, or a person whose presence is necessary to the presentation of the cause.

This post was prepared by an Eckert Seamans attorney.

The Court of Chancery recently clarified a prior ruling involving DGCL §204, which presented the Court with an issue of first impression about the validity of a stock issuance. In Nguyen v. View, Inc., C.A. No. 11138-VCS (Del. Ch. July 26, 2017), Vice Chancellor Slights analyzed defendant’s motion for reargument, and found that it amounted to little more than a “rehash” of the arguments raised in the Court’s denial of the motion to dismiss.  That ruling was previously detailed on these pages.  The Court ruled in its prior decision that Section 204 does not allow for the ratification of corporate acts previously rejected by the majority of stockholders.

Background: Plaintiff, Paul Nguyen, was the majority common stockholder of the corporate defendant, View Inc., in 2009 when defendant sought to issue Series B preferred stock.  Plaintiff consented to the issuance of the Series B preferred stock, in connection with the settlement of certain disputes with the defendant.  Plaintiff’s consent, however, was subject to a 7 day revocation period.  Before the expiration of the 7 day revocation period, defendant issued the Series B preferred shares unbeknownst to plaintiff.  Plaintiff then exercised his right to revoke his consent within the prescribed 7 day window.

Defendant then pursued additional rounds of financing, and raised $500 million. Plaintiff filed an arbitration action against defendant seeking to invalidate the Series B issuance.  The arbitrator found that plaintiff had properly revoked his consent and declared the Series B issuance as “void and invalid.”

Defendant then sought to validate its capital structure by ratifying its capital-raising efforts via 8 Del. C. §204.    Plaintiff filed a verified Complaint seeking a “declaration of invalidity” under 8 Del. C.  §205.  Defendant filed a motion to dismiss the Complaint.  Section 204 permits a corporation to ratify certain acts that would otherwise be void or voidable due to the corporation’s failure to follow applicable statutes or its own governance documents.  Section 205 vests the Court of Chancery with jurisdiction to review disputes arising under Section 204.  Section 205 actions may involve requests by the corporation for validation of its ratifying conduct and/or requests by other litigants to invalidate the corporation’s purported ratification.

Analysis:  The Court denied the motion to dismiss, finding that plaintiff had pled facts supporting a reasonable inference that the Series B issuance was invalid, and that 8 Del C.  §204 did not afford any relief to defendant.  The Court noted that the issue was one of first impression: “whether a corporate act that the majority of shareholders entitled to vote thereon deliberately declined to authorize could retroactively be authorized.”

Key Holding: After examining the legislative history of Section 204, Vice Chancellor Slights found that Section 204 did not permit the subsequent ratification of corporate acts expressly rejected by the majority of stockholders.

The Court denied defendant’s motion for reargument because defendant offered no additional factual or legal bases in addition to its arguments advanced in the first instance. Accordingly, the Court found that “View has failed to identify any law or facts that the Court misapprehended or failed to consider.”

Practice Tip: The Court gently chastised the defendant, in a footnote, for its assertion that the Court misapprehended the operative timeline of the key facts at issue.  The Court had stated in the introductory section of its written opinion that the plaintiff revoked his consent prior to the issuance of the Series B preferred shares.  The Court noted that its general, introductory statement could not be construed as a factual misapprehension by the Court, and that such a contention “comes with little grace.”   Finally, this is an example of the “low odds of success” when filing a motion for reargument based on Rule 59(f).

A recent decision of the Delaware Court of Chancery needs to be consulted by anyone who seeks to fully understand the prerequisites under the Delaware General Corporation Law for effective restrictions on the transfer of stock. Henry v. Phixios Holdings, Inc., C.A. No. 12504-VCMR (Del. Ch. July 10, 2017).

The prerequisites under DGCL Section 202 include actual knowledge of the restrictions and consent by the stockholder to the stock transfer restrictions.  The court explained in this useful decision why the requirements of Section 202 were not met based on the facts of this case, and why those restrictions cannot be retroactive unless additional requirements are satisfied.

A longer discussion of this case will be published as part of my regular column for the National Association of Corporate Directors’ publication called Directorship.

The Court of Chancery recently addressed claims for fraudulent conveyance, and relief available for such claims, in Duffield Associates, Inc. v. Lockwood Brothers, LLC, C.A. No. 9067-VCMR (Del. Ch. July 11, 2017). Court of Chancery Rule 9(b) requires that averments of fraud or mistake shall be stated with particularity, as compared to other claims which may be averred generally.

The court described the elements of Section 1304 of the Delaware Uniform Fraudulent Transfer Act, and referred to remedies available to creditors defrauded by debtors who transfer assets improperly. In this case, there was no genuine issue of material fact as to insolvency.  This opinion has practical application in its description of the prerequisites for establishing a fraudulent transfer under the statute and for providing a reminder that any court of equity has “broad latitude” in crafting a remedy appropriate to the circumstances of a fraudulent transfer.  Those remedies are cumulative and non-exclusive.

In this case, the court granted the remedies sought of constructive trust, a full accounting of the proceeds of distributions, and a disgorgement of any profits or proceeds from the transfers.

 

Much has been written about the new Model Rule of Professional Conduct that the American Bar Association (ABA) adopted in August 2016. My ethics column in the November/December 2016 edition of The Bencher, the national publication of the American Inns of Court, explained how the new ethics rule, which the various states can decide to adopt–or not–expands in an amorphous manner the concepts of discrimination and harassment. That article quoted from law professors who teach legal ethics and constitutional law, as well as other commentators.

Since that publication, which raised questions about the rule, the scholarship on the topic now includes several law review articles, including Andrew F. Halaby and Brianna L. Long, New Model Rule of Professional Conduct 8.4(g): Legislative History, Enforceability Questions, and a Call for Scholarship, 41 J. Leg. Prof. 201 (2016-2017)(Halaby Article); Note, Discriminatory Lawyers in a Discriminatory Bar, 40 Harvard J. Law & Pub. Pol. 773 (June 2017)(Harvard Note).

It is a violation of the new Model Rule 8.4(g) to engage in discrimination based on “race, sex, religion, national origin, ethnicity, disability, age, sexual orientation, gender identity, marital status, or socioeconomic status in conduct related to the practice of law.” Discrimination includes “verbal” conduct that “manifests bias.” The eleven protected categories are not entirely inclusive. Omitted from the classifications are such personal attributes as weight, height and veteran status, for example.

For the first time since I started writing the ethics column for The Bencher over 20 years ago, someone wrote a letter to the editor about my column. The author of that letter about my column on the new rule was the president of the ABA. The issues raised by the new model rule deserve a robust analysis and scholarly debate. A few recent law review articles contribute to that goal. More scholarship on the topic is needed. This short essay merely identifies some of the aspects of the recently promulgated model rule that require further study before being adopted by the various states.

Let’s start with the basic premise that everyone should abhor illegal discrimination and harassment in all its nefarious forms. One of the issues created by the new model rule, however, is that it expands the concepts of both discrimination and harassment in a way that reasonable people can, and do, sincerely differ about. Should we impose serious penalties on, and describe as a violation of legal ethics, conduct that reasonable and ethical people sincerely disagree about for intelligent reasons?

It deserves mention that the membership of the ABA counts for a relatively small fraction of all lawyers in the U.S. Yet, the leadership of the ABA is making normative judgments, and setting moral standards, for a majority of the lawyers in this country on a matter about which most of the country is deeply divided. As the Halaby Article explains, the process used to adopt Model Rule 8.4(g) did not benefit from the same level of participation and the same lengthy comment period as did many of the prior major changes in the rules that govern the legal profession. Remember that these rules subject those who violate them to possible loss of their license to practice law and their ability to make a living.

In their zeal to create a utopia, which some might view as a dystopia, the authors of the new model rule have not avoided the fallacy that the end always justifies the means, or to use another maxim: they threw the baby out with the bath water. We should “keep the baby” and find a more nuanced approach to eliminating the bath water–in this case, unwanted discrimination, harassment and lack of diversity in the profession.

The British statesman William Pitt the Younger was attributed with the observation that “necessity is the plea for every infringement of human freedom.” We can all agree that invidious discrimination and harassment should be condemned, but not everyone agrees that other fundamental rights should be trampled on in order to achieve the goal of banning such discrimination and harassment.

One of the problems with the rule is vagueness. It lacks a definition for what it prohibits: discrimination, harassment and applying that behavior to socioeconomic status, for example. Definitions in substantive law, and other sources, can certainly be used as a reference, but they are not uniform and may not apply in all contexts. The Halaby Article describes the new model rule as being “riddled with unanswered questions, including but not limited to uncertainties as to the meaning of key terms…as well as due process and First Amendment free expression infirmities.” Others are more supportive.

Although the Harvard Note argues that amendments to the new model rule should be made before states begin adopting it, overall it supports a codification of the moral judgment that discrimination and harassment are cardinal sins that must be banned from the legal profession. What constitutes a sin, however, needs to be defined. An inherent problem of the ABA’s attempt to use new Model Rule 8.4(g) to codify moral judgments, is that the ABA membership constitutes a small percentage of all lawyers in America and reasonable people can differ about whether the leadership of that group is the appropriate elite to adopt rules that impact personal behavior beyond the administration of justice–much like the magisterium of a church would articulate rules that apply to all areas of one’s personal life – – not only rules governing the practice of law.

The Delaware Court of Chancery is a court of equity with limited jurisdiction. Contrary to what some may assume, not all corporate and commercial litigation can be heard in this famous court. (Delaware’s trial court of general jurisdiction is the Superior Court.) A recent opinion has practical application for litigators to the extent that it applies the well-traveled, but not often well understood, nuances of the limited scope of the equitable jurisdiction of the Delaware Court of Chancery. Yu v. GSM Nation, LLC, C.A. No. 12293-VCMR (Del. Ch. July 7, 2017).  This letter decision explains the three ways to secure equitable jurisdiction, but the court reminds practitioners that the mere incantation of key words invoking equitable relief will not suffice.

The background of this case includes a request to pierce the corporate veil, about which the Court of Chancery has exclusive jurisdiction. In addition to serving as an example of how difficult it is to successfully pierce the corporate veil, this decision explains why the Superior Court could provide adequate relief to the plaintiff by providing a money judgment.  There was insufficient detail in the pleadings to explain why a money judgment could not be paid, and therefore the court dismissed the complaint with leave to refile or transfer the case to the Superior Court within 60 days pursuant to 10 Del. C. § 1902. See generally footnotes 7, 9 and 10 regarding equitable jurisdiction, and also 10 Del. C. § 342, re: Chancery’s limited jurisdiction.

Also of practical application is the discussion by the court in this letter ruling of the exclusive jurisdiction that Chancery has over equitable fraud claims, but in this case there was no basis for an equitable fraud claim. The use of the words alone to allege equitable fraud claims is not enough.

In addition, the court explained that in some instances the Superior Court and the Court of Chancery may both entertain claims for unjust enrichment, but if the unjust enrichment claim, as in this case, is merely a contract-related theory of recovery that accompanies a breach of contract allegation, then the claim is only legal, and not equitable. See footnote 25.

For my latest column in Directorship, the publication of the National Association of Corporate Directors, I discuss a recent Delaware Supreme Court decision that addresses fiduciary duties as modified in the context of a limited partnership agreement. The case of Brinckerhoff v. Enbridge Energy Company was previously highlighted on these pages, but the opinion remains required reading for any lawyer who needs to know the latest Delaware law regarding how fiduciary duties can be modified by agreement in non-corporate entities, and the interfacing of those modified duties with the implied covenant of good faith and fair dealing. Professor Stephen Bainbridge, friend of this blog, kindly linked to the referenced column.

A recent letter opinion provides a practical description of the elements required to satisfactorily plead a breach of fiduciary duty claim, as well as a definition of situations where a fiduciary relationship may be found. In Beach to Bay Real Estate Center, LLC v. Beach to Bay Realtors, Inc., C.A. No. 10007-VCG (Del. Ch. July 10, 2017), the Court of Chancery also observed the non-controversial truism that minority members of LLCs generally do not owe fiduciary duties to the LLC or other members.

The court explained that in Delaware a fiduciary relationship may be found in:

“. . . a situation where one person reposed special trust in and reliance on a judgment of another or where a special duty exists on the part of one person to protect the interest of another.” See footnote 68.

Moreover, the court explained that there “must be an allegation of an agreement supplying such a duty or a special relationship creating such a duty.” The court observed that in its experience, “thieves and their victims rarely consider their relationship an equitable one on account of that status alone.  Rather, there must be some repose of special trust . . . or reliance . . ..”

The court allowed, however, for the possibility that “in certain circumstances a minority member of an LLC, with access to confidential information, could stand in a fiduciary relationship to the entity or other members.” But, non-conclusory allegations in support of a relationship creating such a duty were found lacking in the complaint in this case.

As an aside, this decision also features quotes from William Faulkner and colorful language about procedural irregularities concerning this matter.

This post was prepared by an Eckert Seamans associate.

The Court of Chancery recently announced an amendment to Court of Chancery Rule 171, to take effect on August 1, 2017, regarding word limits to motions and letters to the Court and the requisite certificate of compliance. The word limitations applicable to motions filed pursuant to Rules 12, 23, 23.1, 56 and 65 and to pre-trial and post-trial briefs are the same as exist in current Rule 171.  The amended Rule 171 will require opening briefs for motions filed pursuant to Rules 12, 23, 23.1, 56 or 65 and opening pre-trial or post-trial briefs not to exceed 14,000 words.  The answering brief filed shall also not exceed 14,000 words.  The reply brief shall not exceed 8,000 words.

The principal difference articulated in amended Rule 171 is that “[a]ll other applications [other than pursuant to Rules 12, 23, 23.1, 56 and 65 and pre-trial and post-trial briefs] shall be made by motion without a supporting brief” and shall be limited to 3,000 words or less. The opposition to such motions shall not exceed 3,000 words and the reply shall not exceed 2,000 words.

The Court of Chancery is curtailing the verbiage permitted for the many types of motions which are not governed by Rules 12, 23, 23.1, 56 or 65, such as: motions in limine; motions to compel; motions for certification of interlocutory appeals; motions for leave to amend pleadings; motions to intervene; and motions for new trial. As practitioners are aware, the categories of motions governed by the more limited word count often involve complex legal issues and are often submitted in full-brief format in current practice.  Starting August 1, 2017, brevity will become mandated for these types of motions.

Amended Rule 171 also limits letters to the Court to 1,000 words, and states that such letters should be used for “logistical and scheduling issues” and not for substantive relief.

Amended Rule 171 also will require the word count to be stated in the signature block of the filed document governed by Rule 171(f). This requirement presumably is intended to eliminate the situation where one attorney signs the brief and another person signs the certificate of compliance.  Under the new Rule 171, the signatory(ies) of the brief will also be certifying the word count compliance statement.

 

The recent decision from the Delaware Court of Chancery in Williams v. Ji, C.A. No. 12729-VCMR (Del. Ch. June 28, 2017), provides important insights into the Delaware law applicable to challenges to voting agreements among stockholders, as well as to director compensation packages. (By the way, Happy July 4th to all my loyal readers. We should all stop to reflect on the blessings of liberty we enjoy on this Independence Day holiday.)Related image

Background Facts: The allegations were based on a plan in which directors granted themselves options and warrants for the stock of five subsidiaries over which the corporation has voting control. Around the time those options were granted, the board transferred valuable assets and opportunities of the corporation to the subsidiaries.  A stockholder challenged the grants as a breach of fiduciary duty due to the excessive value that was given in the form of compensation.  The complaint also alleged that the voting agreements amounted to illegal vote buying to the extent that a stockholder was required to vote its shares in a manner that the board of directors instructed.

Issues Addressed: The key issues addressed included whether the business judgment rule or the entire fairness standard would apply to the decisions by the board to grant themselves options as a form of compensation, and whether or not the voting agreements were deficient in some manner.  The court also addressed the issue of ripeness and whether or not the issues relating to the voting agreement were hypothetical because the voting agreement only represented a small percentage of the voting shares and did not determine the outcome of any elections to date.

Key Legal Principles Addressed: The court relied on a recent Delaware Supreme Court decision that defined ripeness to include claims that have “matured to a point where judicial action is appropriate.”  Moreover: “a dispute will be deemed ripe if litigation sooner or later appears to be unavoidable and where the material facts are static.” (citing XL Specialty Ins. Co. v. WMI Liquidating Trust, 93 A.3d 1208, 1217 (Del. 2014), highlighted on these pages.) In this instance, the court found sufficient static material facts to determine whether entering into the voting agreement constituted a breach of fiduciary duty, and distinguished the decision in In re: Allergan, Inc. Stockholder Litigation, 2014 WL 5791350 (Del. Ch. Nov. 7, 2014), highlighted on these pages, because in that case the court dealt with an interpretation of a bylaw in a hypothetical situation that had not yet come to fruition.

Regarding the standard applicable to executive compensation decisions, the court explained the well-settled Delaware law that: “Self-interested compensation decisions made without independent protections are subject to the same entire fairness review as any other interested transaction.” (citing Valeant Pharm. Int’l v. Jerney, 921 A.2d 732, 745 (Del. Ch. 2007), highlighted on these pages).  The court explained the well-known aspects of the entire fairness standard that include both fair dealing and fair price.  The court also observed that application of entire fairness review typically precludes dismissal of a complaint on a Rule 12(b)(6) motion to dismiss.  Where a complaint is adequately plead that the board lacks independence, and alleges a claim for excessive compensation, the plaintiff “only need allege some specific facts suggesting unfairness in the transaction in order to shift the burden of proof to defendants to show that the transaction was entirely fair.” (citing In re: Tyson Foods, Inc., 919 A.2d 563, 589 (Del. Ch. 2007), highlighted on these pages.) In this case, the court determined that the complaint satisfied that standard by pleading “some specific facts suggesting unfairness” in the options involved–thereby shifting to defendants the burden of proving that the grant of the options was entirely fair.

Regarding the unfair process analysis, the complaint alleged that noone other than the interested directors ever approved the challenged grants.  The grants were also timed around the transfer of valuable assets or opportunities to subsidiaries and the grants were not disclosed as compensation but rather were disclosed in a proxy statement as “related-party transactions.”  The court reasoned that those allegations gave rise “to at least a reasonably conceivable inference of unfair process.”

Regarding the fair price element, the court referred to an allegation where one of the defendants alone was granted the right to 18% of the economic value of one of the subsidiaries which was estimated to be worth $178 million, thereby making his interest worth over $30 million.  The court cited to the 1995 decision in Steiner v. Meyerson, 1995 WL 441999 at * 7 (Del. Ch. July 19, 1995), which refused to grant a motion to dismiss when merely $20,000 per year compensation for director service was challenged under the entire fairness standard.  [Of course, most readers will be familiar with the Delaware decision involving the Disney Company where the court found that a payment of approximately $140 million for severance pay to an executive named Ovitz, who was only at the company for about one year and whose performance was less than stellar, was not found to be in violation of the board’s fiduciary duty.  Therefore, specific facts and circumstances matter, and the amount of compensation is not necessarily determinative.]

Regarding the voting agreement issue, DGCL Section 218(c) explicitly authorizes certain voting agreements to be entered into.  The Court of Chancery in unrelated decisions in the past, previously ruled that the transfer of stock voting rights without the transfer of ownership is not per se illegal.  See footnote 31.  In order to be illegal, a vote-buying agreement must have as its primary purpose either to defraud or in some way to disenfranchise other stockholders.  In a prior decision involving voting agreements, the court explained that two of more stockholders may “do whatever they want with their votes, including selling them to the highest bidder.”  See footnote 35.  However, the counter balance to that statement is that:  “management may not use corporate assets to buy votes unless it can be demonstrated, as it was in Schreiber, that management’s vote-buying activity does not have a deleterious effect on the corporate franchise.”  See footnotes 35 and 36.

In this case, corporate assets were used to buy the votes and based on the facts of this case, the burden shifted to the defendants to prove that the agreement was intrinsically fair and not designed to disenfranchise other stockholders.  Making reasonable inferences in favor of the plaintiff at this early stage, the complaint adequately alleged a disenfranchisement purpose.