In a recent letter ruling, the Delaware Court of Chancery provided a practice tip for those engaged in litigation before the court who seek an extension of the word-limit for briefs: Don’t present the court with a “Morton’s Fork.” That is, don’t make the court choose between two equally unappealing alternatives by waiting until the last business day before the brief is due. In a prior opinion in the Hermelin case highlighted on these pages, at the famous footnote 19, the court explained the difference between other somewhat similar expressions, like Hobson’s Choice, that can easily be conflated. Kandell v. Niv, C.A. No. 11812-VCG (Del. Ch. Oct. 14, 2016).

The Delaware Court of Chancery recently provided an exemplary explanation of Delaware law on the requirements that must be met before directors can be found liable for breaching their duty of oversight. Reiter v. Fairbank, C.A. No. 11693-CB (Del. Ch. Oct. 18, 2016).

Key Background Facts: This case involved a claim that the board of directors of Capital One Financial Corporation breached its fiduciary duties of oversight in connection with its alleged failure to adequately monitor the bank’s activities in connection with check cashing services, and in particular, allegedly failed to monitor compliance with the federal laws and regulations regarding money laundering.

Key Legal Principles Addressed: The Court of Chancery found that the standard under Delaware law for imposing oversight liability, sometimes referred to as Caremark liability, requires evidence of bad faith, meaning that “the directors knew that they were not discharging their fiduciary obligations.”

The court reasoned that this type of claim, often described as one of the most difficult to prevail upon in corporate litigation, failed to allege facts from which it reasonably may be inferred that the defendant directors consciously allowed Capital One to violate the federal requirements so as to demonstrate that they acted in bad faith.  Specifically, the plaintiff failed to plead with particularity that a majority of the directors of Capital One faced a substantial likelihood of liability.

It would take more space than typically allocated for a blog post to recite the excellent recitations of the law by the court regarding the nuances and prerequisites of both: (1) the duties of oversight of the board of directors, which is part of the duty of loyalty, a subset of which is the duty of good faith; and (2) the prerequisites for a plaintiff to successfully allege a breach of the duty of oversight such that it will survive a motion to dismiss under either Rule 23.1 or 12(b)(6).

Several gems can be found on pages 14 and 15 of the slip opinion, in which the court explains that the Rales test applies in this context as opposed to the Aronson because in connection with a Caremark claim, it is the lack of action by a board or an alleged violation of the board’s oversight duties that must be examined as opposed to an allegedly improper decision.

In addition, the prerequisites that must be satisfied by a plaintiff alleging a Caremark claim are usefully enunciated in page 17 through 20 of the slip opinion.

I will provide a few selected excerpts, but those needing to know the nuances of Delaware law on this topic need to read the whole opinion.The court explained that in order to establish a breach by the directors of their fiduciary duty by failing to adequately implement controls and monitoring procedures, plaintiffs would need to show either:

“(1)  That the directors knew, or (2) should have known that violations of law were occurring and, in either event, (3) that the directors took no steps in a good faith effort to prevent or remedy that situation, and (4) that such failure approximately resulted in the losses complained of.”

The opinion referred to the Delaware Supreme Court’s reinforcement of the Caremark framework for director oversight liability by clarifying that:  “To impose personal liability on a director for failure of oversight requires evidence that the directors ‘knew that they were not discharging their fiduciary obligations.’”  See footnote 48 and accompanying text.

An Eckert Seamans associate prepared this overview.

A recent Chancery opinion held that stockholder approval and the business judgment rule barred fiduciary duty claims against a board that dissolved the company. The Huff Energy Fund, L.P. v. Gershen, C.A. No. 11116-VCS (Del. Ch. Sept. 29, 2016)

Background: The Delaware Court of Chancery recently dismissed a stockholder’s breach of contract and fiduciary claims against a dissolving company. This action stems from Defendant Longview Energy Company’s (“Longview”) decision to dissolve Longview after the company sold a significant portion of its assets.  Plaintiff, The Huff Energy Fund (“Huff”), was the largest Longview stockholder, holding approximately 40% of Longview’s common stock. Huff brought suit to challenge the dissolution.

A Shareholders Agreement (the “Agreement”) between Huff and Longview required a unanimous vote of the Board for any act having “a material adverse effect on the rights of [Longview’s stockholders], as set forth in” the Agreement. The Agreement also provided Longview with the right of first offer if Huff were to transfer any shares, and provided that the company would continue to exist and remain in good standing under the law.

The sale and dissolution plan at issue was approved by the Longview Board and shareholders, over the abstention of one Huff board designee.

Huff’s Allegations: Huff alleged that Longview breached the Agreement because the dissolution had “a material adverse effect” on its right to transfer its Longview stock to Longview. Accordingly, Huff alleged that the Board’s decision was subject to the unanimity requirement. Additionally, Huff asserted that dissolution violated the obligation to “continue to exist.” Finally, Huff brought a fiduciary claim against the Board for adopting the dissolution plan without exploring more favorable alternatives in violation of Revlon, and as an unreasonable response to a perceived threat in violation of Unocal.

Court’s Analysis: The court first held that the individual Board defendants could not be liable for breach of contract because they signed the Agreement as company representatives, and not in their individual capacities. Additionally, Huff failed to adequately plead a tortious interference claim, as the allegations were improperly raised for the first time in briefing.

Next, the Court held that Huff failed to plead breach of contract against the Board. Huff argued that the unanimity requirement applied to any act effecting any right referenced in the contract. However, the Court found that Huff’s interpretation contradicted common sense. Huff’s interpretation would unreasonably subject all extra-contractual “rights” to the unanimity requirement, solely because they were referenced in relation to another right actually created by the Agreement. Therefore, because the Agreement did not create a “right of transferability” for Huff, but instead allowed Longview the right of first offer, the Court rejected Huff’s argument that the dissolution vote violated the Agreement.

The Court also found that dissolution itself did not breach the Agreement’s provision requiring Longview to “continue to exist and [] remain in good standing under [the law].” The provision was merely a commitment to remain in good standing as a Delaware corporation, and not a “commitment to exist ‘come what may,’” as Huff asserted. Huff’s interpretation was also unreasonable in light of other contract provisions referencing a potential merger or sale.

Next, the Court found that there was no fiduciary violation in approving the transaction. Huff failed to plead that the Board was not disinterested and independent. That the dissolution plan provided severance pay to certain directors, that some members had personal friendships, and that one member acted with alleged “animosity” towards Huff did not indicate that the Board was “interested” in the transaction to a degree that would rebut the business judgment rule. Regardless, despite Huff’s allegations toward individual Board members, Huff failed to plead that a majority of the Board that approved the transaction were not independent. Thus, entire fairness did not apply.

The Court next turned to Huff’s Revlon and Unocal arguments. Revlon did not apply because the applicable policy concerns were absent. Specifically, the adoption of the plan did not constitute a “final stage” transaction or effect a “change of control.” Similarly, Unocal did not apply. The Court noted that Huff “cite[d] no cases…indicating either that (1) the adoption or filing of a certificate of dissolution or (2) the board’s ‘perception’ that a shareholder posed a threat to any individual director’s ‘power’ over the corporation implicates the ‘omnipresent specter’ lingering in those instances where Unocal scrutiny has been invoked.”

Conclusion

Therefore, the Court held that Huff failed to plead any contractual breach or fiduciary violations. The Court also noted the significance of the shareholder vote in addition to Board approval. Even if enhanced scrutiny applied, “the Longview stockholders’ [informed] approval cleansed the transaction thereby irrebuttably reinstating the business judgment rule.” Accordingly, the Court invoked the business judgment rule and dismissed Huff’s complaint in its entirety.

A recent Delaware Court of Chancery opinion provides practical instruction for corporate litigators regarding the difference between a direct v. derivative claim as well as an analysis of the requirements under Rule 23.1, and an application of the two-prong test in Aronson v. Lewis to satisfy the prerequisite of pre-suit demand futility.  Chester County Employees’ Retirement Fund v. New Residential Investment Corp., C.A. No. 11058-VCMR (Del. Ch. Oct. 7,2016). This case involves a challenge to a transaction among affiliated entities.

Key Legal Principles Addressed

The Court conducts an educational description of a direct and a derivative claim, as well as recognition that some claims are both direct and derivative.

The Court also reviewed the standard under Rule 23.1 which embodies the pre-suit demand requirement that must be satisfied for a derivative claim.  The Court reviewed the two-pronged test to demonstrate demand futility with particularized facts that allege a “reasonable doubt” that: (1) the directors are disinterested and independent; and (2) the challenged transaction was otherwise the product of a valid exercise of business judgment.  In addition to providing a definition for determining if a director is “disinterested” as well as “independent”, the Court discusses the second prong which involves the rare case in which a transaction can be shown to be “so egregious on its face that board approval cannot meet the test of business judgment, and a substantial likelihood of director liability exists.”

The Court reviewed the alleged conflicts based on relationships involving interlocking directorships, but found that the plaintiff did not allege sufficient facts to excuse demand. The Court also reviewed the requirements for ripeness and the need for an actual controversy before the Court would hear a declaratory judgment action pursuant to 10 Del. C. § 6501.

An associate at Eckert Seamans prepared this overview.

The Delaware Court of Chancery recently granted injunctive and monetary relief based on the parties’ contractual agreements and obligations. This case involves two Delaware entities that own school meal management software: inTEAM Associates, LLC (“inTEAM”), and Heartland Payment Systems, Inc. (“Heartland”). The action stems from a transaction in which Heartland bought substantially all of the assets of inTEAM’s predecessor, School Link Technologies, Inc. (“SL-Tech”). inTEAM Associates, LLC v. Heartland Payment Systems, Inc., C.A. No. 11523-VCMR (Del. Ch. Sept. 30, 2016).

Background: In the sale, Heartland acquired WebSMARTT, a program categorized by the USDA as Nutrient Analysis Software. Heartland did not acquire inTEAM’s Decision Support Toolkit (“DST”) program. Three agreements, the Asset Purchase Agreement, the Co-Marketing Agreement, and the Consulting agreement, govern the transaction. The collective agreements contain non-competition, non-solicitation, and cross-marketing provisions.

The Asset Purchase Agreement prohibited the parties from providing competitive products or soliciting customers in competition with Heartland’s business. However, inTEAM’s consulting, eLearning, and DST portions of the business were explicitly excluded from the scope of the provision (the “inTEAM carve-out”). Thus, inTEAM could still competitively pursue those aspects of its business.

The Co-Marketing Agreement also contained reciprocal non-competition provisions. Additionally, it contained a provision obligating Heartland to provide inTEAM with marketing support with respect to particular products. Heartland was allowed to terminate the Co-Marketing Agreement if inTEAM did not meet specified sales targets.

The Consulting Agreement provided that Goodman was to act as an advisor to Heartland. It also contained non-competition and non-solicitation provisions.

The parties later agreed that inTEAM could develop a new program based on DST technology: KidsChoose. Heartland was to share beneficial information in exchange for a portion of the resulting revenue. After KidsChoose failed to meet expectations, inTEAM was allowed to develop a new version of the product. Thereafter, Heartland terminated its support obligations under the Co-Marketing Agreement.

In 2014, inTEAM employees emailed a potential customer about providing an inTEAM alternative to Heartland’s WebSMARTT program. Although WebSMARTT contained POS features, inTEAM was interested in adding a POS feature to its current software. inTEAM later sent two additional emails to a school district to obtain information about their current POS software.

In 2015, Heartland and an inTEAM competitor, Colyar Technology Solutions, Inc. (“Colyar”) submitted a joint proposal to Texas for the development of meal management software. After Texas declined Heartland’s proposal, Heartland promised to “ramp up efforts with Colyar[ ]” to bid in other states.

inTEAM then revealed a new program, CN Central, which combined prior DST technology. The USDA classified CN Central as Menu Planning Tool software, as opposed to Nutrient Analysis Software, such as WebSMARTT.

Parties’ Allegations: inTEAM alleges that Heartland breached its non-competition, cross-marketing, and support obligations by partnering with Colyar and failing to support inTEAM’s software development with respect to KidsChoose. Heartland asserts that inTEAM and Goodman breached their non-competition obligations by developing CN Central in competition with WebSMARTT. Additionally, Goodman breached his non-solicitation obligations by participating in inTEAM’s efforts to solicit business from schools.

Court’s Analysis: The court found that inTEAM did not breach its non-competition obligations, as CN Central was based on DST technology covered by the inTEAM carve-out. The carve-out contemplated future versions of DST software, like CN Central, with greater functionality. The Court did not consider Heartland’s extrinsic evidence on this matter because the agreement unambiguously described the carve-out. The agreement documents plainly discussed the “future release” of DST technology, and anticipated the development of a product with functionality that did not exist at closing.

Heartland also argued that CN Central competed with WebSMARTT because both programs had the ability to analyze nutrients. However, CN Central, a Menu Planning Tool, could only perform a subset of the abilities of Nutrient Analysis Software, such as WebSMARTT. Heartland argued that the USDA’s software classifications were not dispositive, as the programs had overlapping functionality. However, the Court explained that the USDA classifies the various software according to their functionality. Thus, CN Central did not compete with WebSMARTT.

With respect to Heartland, the Court found that it breached its non-competition obligations when it collaborated with inTEAM’s competitor, Colyar, to produce software covered by the scope of inTEAM’s business. It did not matter that the anticipated technology never came to fruition. However, Heartland did not breach its support obligations relative to KidsChoose. KidsChoose was a brand of Heartland’s software, and Heartland validly terminated those obligations in 2013. Regardless, inTEAM did not point to any evidence that Heartland failed to provide adequate cross-marketing aid. Moreover, there was no evidence Heartland caused any problems with the unsuccessful version of the program.

Finally, with respect to Goodman, the Court found that he did not breach his non-competition obligations as a result of the inTEAM carve-out. As discussed, CN Central did not compete with WebSMARTT, despite similar functionality. Additionally, an email evidencing inTEAM’s interest in developing POS features was not proof that inTEAM was actively engaging in selling POS software. However, the Court found that Goodman did breach his non-solicitation obligations when he encouraged a school district to adversely modify its existing relationship with Heartland by proposing an alternative tool to WebSMARTT.

Conclusion: In finding that no equitable defenses applied, the Court granted inTEAM an injunction because: (1) it showed actual success on the merits; (2) breaching a covenant not to compete is an irreparable injury; and (3) the balance of equities favored inTEAM because Heartland agreed to the non-compete covenant, and inTEAM would continue to suffer harm contemplated by the agreements if the behavior continued. However, inTEAM was not entitled to costs and fees pursuant to the language of the agreements.

Similarly, Heartland was entitled to an injunction regarding Goodman. The parties contractually agreed that an injunction was the appropriate remedy for the specified violations. In balancing the equities, the court limited the injunction to six months from the execution date. Unlike inTEAM, Heartland was entitled to damages pursuant to the agreement language.

A recent Chancery opinion addressed several key legal principles with broad application to corporate and commercial litigation in Delaware. In Nguyen v. Barrett, C.A. No. 11511-VCG (Del. Ch. Sept. 28, 2016), the court addressed several notable topics in connection with claims challenging a merger agreement.

For example, the court explained what was needed to successfully defend a Rule 12(b)(6) motion when trying to rebut the business judgment rule and trying to overcome the exculpatory provisions of DGCL Section 102(b)(7). See Slip op. at 12-14.

In addition, the court discussed the standards of review that apply to disclosure claims made prior to, and after, closing–as well as related nuances and consequences regarding the timing of those claims.