Search Section 228

A recent Delaware Court of Chancery decision provides noteworthy rulings on the limited scope of a Section 225 summary proceeding regarding the proper composition of the board of directors, as well as the notice requirements for a written consent in lieu of a stockholders’ meeting pursuant to Section 228 of the Delaware General Corporation Law (DGCL). See Brown v. Kellar, C.A. No. 2018-0687-MTZ (Del. Ch. Dec. 21, 2018). Many Section 225 cases and Section 228 cases have been highlighted on these pages over the last 14 years.

Three Important Topics Addressed:

Although the factual details of this case are necessary to understand the holding that denied in part the motion for summary judgment, for purposes of the most widespread applicability for those involved in corporate litigation, I will highlight the key takeaways that include memorable statements of Delaware law on three important topics:

(1) the circumscribed scope of Section 225 summary proceedings;

(2) the impact of not providing prompt notice of a written consent of stockholders under Section 228; and

(3) the impact, if any, on the effectiveness of a Section 228 written consent if the notice requirements under Rule 14c-2 of the Securities Exchange Act of 1934 are not complied with—assuming full compliance with Section 228.

Brief Background:

This case involved a stockholder who brought an action to determine the composition of the board of directors pursuant to Section 225 of the DGCL.

Procedurally, the opinion addressed a motion for summary judgment to determine the proper members of the board. As often happens in these matters, there is a parallel plenary action that raises issues regarding a breach of fiduciary duty and which also seeks a declaratory judgment.

At the heart of the dispute is whether certain written consents in lieu of a stockholders’ meeting to remove an incumbent director, then to replace him with another director, was valid and effective upon delivery.  The counterargument was that the court should not grant summary judgment in order to allow it to consider issues of inequitable conduct that would allegedly void the written consents.

In addition to the issue of whether prompt notice under Section 228(e) of the DGCL was a condition precedent to effectiveness of the written consent under Section 228, another issue addressed is whether or not the notice requirements under Rule 14c-2 of the Securities Exchange Act of 1934 supersede the notice requirements under Section 228.

Key Takeaways

Section 225 Principles:

  • Whether or not an issue other than the proper composition of the board should be considered by the court in a summary Section 225 proceeding turns: “upon a determination of whether it is necessary to decide in order to determine the validity of the election . . . by which the defendant claims to hold office.” See footnotes 41 through 44 and accompanying text.
  • Although the summary nature of a Section 225 proceeding limits the scope of issues that will be addressed, Delaware courts “reject the notion that rigid, inflexible rules preclude this court from hearing anything but the narrowest arguments in Section 225 cases.”
  • Rather, the court may adjudicate a claim that a director does not validly hold corporate office because that director obtained the office through fraud, deceit, or breach of contract . . . but only for the limited purpose of determining the corporation’s de jure directors and officers. See footnote 40 and accompanying text.
  • Section 225 proceedings are in rem, meaning that the defendants “are before the court, not individually, but rather, as respondents being invited to litigate their claims in the res (the disputed corporate office) or be forever barred from doing so.” See footnote 39 and accompanying text.
  • Prior decisions by the Court of Chancery exemplify the ability of the court to review appropriate claims of inequitable conduct within the boundaries of a Section 225 case. See footnotes 47 through 49 and accompanying text.
  • The court will review issues “that could infect the composition of a company’s de jure directors and officers under Section 225, notwithstanding formal compliance with the voting procedures and requirements for those offices.” See footnotes 50-51 and accompanying text.
  • The court explained that it may consider the well-known principle announced in Schnell v. Chris-Craft Industries, 285 A.2d 437, 439 (Del. 1971), that “inequitable action does not become permissible simply because it is legally possible.” Schnell, 285 A.2d at 439.
  • The court reasoned that Schnell empowers the court in a Section 225 case to look at both technicalities and equities notwithstanding the relatively narrow scope of a Section 225 proceeding.
  • The “twice tested principle” of Delaware corporate law applies in 225 cases. That is, under Delaware law: “in every case, corporate action must be twice tested: first, by the technical rules having to do with the existence and proper exercise of the power; second, by equitable rules.” See footnote 52.

Section 228 Principles:

The court quoted from subsection (e) of Section 228 which requires prompt notice of the taking of corporate action by less than unanimous written consent of stockholders in lieu of a meeting. The sub-issue involved in this case was whether the absence of that notice under Section 228(e) prevents an otherwise valid written consent from taking effect. Based on the facts of this case, the court answered that question in the negative.

  • Section 228 unambiguously permits a majority of the stockholders of a corporation to act immediately and without prior notice to the minority. See footnotes 58-59.
  • Section 228(a) provides as a condition precedent that pursuant to Section 228(c) the consents must be “properly delivered” in order to be effective. See footnote 60 and accompanying text. In contrast, Section 228(e) does not make notice to the minority a condition precedent to an effective written consent.
  • Section 228(e) is not a condition precedent or a prerequisite to a corporate action by written consent but, the court explained that it is: “rather an additional obligation resulting from that corporate action.” See Slip op. at 23.
  • Nonetheless, the court emphasized that “prompt notice to the minority stockholders is of critical importance. Failure to provide that notice has, in unique circumstances, compelled the Court to deviate from the default rule that written consents are effective upon delivery.” Id.
  • The court referenced cases where egregious failure to provide that notice to non-consenting stockholders for several months resulted in the effectiveness under the default rule being delayed until notice requirement was remedied. See footnotes 65 through 71 and accompanying text.
  • The court found based on the facts of the instant matter that the foregoing “extreme” exception to the default rule was an applicable. Slip op. at 25.

Interface of Section 228 and Rule 14c-2 of the Exchange Act:

The court referred to other Delaware decisions that addressed the interfacing between Delaware corporate law requirements and Federal securities law and regulations.

  • The failed argument in this case was that Rule 14c-2 of the Securities Exchange Act of 1934 provided an independent notice requirement that precludes effective written consents until notice is given but “at the same time prevents [the company in this case] from giving that notice.” See footnotes 72 through 79 and accompanying text.
  • The court explained that the parties did not brief the issue of the jurisdiction of the Court of Chancery to interpret Rule 14c-2, but the court assumed without deciding that it could address the impact of that Rule on the validity of the written consents at issue in this case—based on Delaware law.
  • The parties also agreed that the Exchange Act Rules did not preempt Delaware law. See footnotes 79-80.
  • The court wrote that important policies underlying the Internal Affairs Doctrine suggest that the power of the state of incorporation should not be lightly overturned, but in any event the court held that its application of Section 228 to the written consents at issue “is not affected by Rule 14c-2.” Slip op. at 29.
  • The court reasoned that “even if Rule 14c-2 imposes a notice requirement beyond that found in Section 228, the Director Consents would still be effective under Delaware law. This court has consistently found that corporations cannot avoid their obligations under Delaware law, like holding annual meetings, by pointing to additional or reportedly conflicting obligations under Rule 14 of the Exchange Act.” See footnotes 81-82 for supporting case law.
  • The court observed a fundamental problem with the argument made by the Director Defendants as it relates to the interaction between federal law and Delaware law. The federal rule was meant to reinforce management accountability to stockholders and it cannot be used as a tool to indefinitely deprive stockholders of the franchise. See footnote 88. The Director Defendants in this case offer Rule 14c-2 as a basis to avoid giving stockholders notice, and the court rejected that argument.
  • The argument that Rule 14c-2 and Section 228 operate together to prevent the company from making any disclosure to the stockholders in this situation “stands the purpose of corporate and securities law on its head.” See footnote 91 and accompanying text.
  • Ultimately, the court found that it need not make a ruling on the substance of Rule 14c-2, because Rule 14c-2 did not “inform” its rulings on Section 228.

Boris v. Schaheen, C.A. No. 8160-VCN (Del. Ch. Dec. 2, 2013).

Issue Addressed:  Whether the written consents of stockholders pursuant to DGCL Section 228 effectively selected new board members.

Brief Overview

This 51-page post-trial decision addressed the effectiveness of written consents of stockholders that were designed to select new board members.  The two entities involved were controlled by family members who had an informal corporate governance system.  The directors did not hold the proper board meetings and did not record proper board minutes.  The directors did not formally document the issuance of shares and the official stock ledger was not maintained in a manner which allowed the number of shares issued to each stockholder to be free from doubt.  The parties disputed what the exact number of shares were that each of them owned.

Written Consent of Stockholders

The two companies involved in this case are Numoda Corporation and Numoda Technologies, Inc.  The Numoda Corp. bylaws allowed stockholders to act by written consent.  First, the plaintiffs, John and Ann, delivered the Numoda Corp. Written Consents to the registered agent of the company and then filed the consents with the books and records of the company.  Then, two days later, as the purported directors of Numoda Corp., John and Ann executed a unanimous written consent of directors in which they resolved, that “no officer of Numoda Corp. shall take any action on behalf of the company without the prior written consent of the board.”

Similar to the Numoda Corp., Numoda Technologies, Inc. (“Numoda Tech”) had a stock book in which most stock issuances were not properly documented nor did the corporate records include board approval of corporate acts.  The parties understood Numoda Tech to be a wholly owned subsidiary of Numoda Corp.  It was disputed whether Numoda Tech ever issued stock from the time it was incorporated to be a subsidiary of Numoda Corp.  No Numoda Tech stock certificates were ever issued.  The plaintiffs, John and Ann, took the position that because no stock was ever issued, Numoda Tech is a corporation with no stockholders.  It was disputed who the original members of the board of Numoda Tech were.

The Numoda Tech bylaws also allow stockholders to act by written consent.  Just as they did in connection with Numoda Corp., John and Ann, as purported majority stockholders, delivered a written consent of Numoda Tech stockholders.

Legal Analysis

This action was brought pursuant to Section 225 of the DGCL which allows any stockholder or director to petition the court to determine the validity of the removal or appointment of a director.

The Court explained that the DGCL contemplates, generally, a formal approach to corporate governance especially relating to changes in the capital structure.  The DGCL implies an affirmative duty to maintain the stock ledger.  See footnote 159.  See also DGCL Section 219(c) (the stock ledger shall be the only evidence as to the stockholders who are entitled to vote in person or by proxy or by written consent).

If the corporation does not have a stock ledger then the Court may consider extrinsic evidence to determine stock ownership.

Stock is not validly issued unless the board of directors exercises its power to issue stock in conformity with statutory requirements.  The Court addressed two related questions that are implicated:  (1) whether the DGCL requires a written instrument evidencing board approval to issue common stock; and (2) whether, if a written instrument is required, the lack of such approval by a written instrument renders the issued stock void or voidable.  Although these issues have been addressed in Delaware as they relate to preferred stock, no cases have been presented previously to the Court involving a common stock issue.  See footnote 166.

The Court discussed the recent amendments to the DGCL, adding Sections 204 and 205, that address the ability to correct defective corporate acts and to clarify the distinction between void and voidable acts.  The Court discussed public policy reasons behind the strict requirement of a written instrument for a stock issuance implicated by DGCL Section 151(a), among other provisions.  One of the reasons for such a bright line rule is that it promotes certainty that facilitates investments in stock.

The Court cited established Delaware law for the position that:  “Stock issued without authority of law is void and a nullity – – and this includes stock that is not issued pursuant to a written instrument evidencing board approval.  That the stock is void means that it cannot be remedied by equity . . ..”  See footnote 176.  The Court explained that:  “Put simply, for changes to the corporation’s capital structure, law trumps equity.”  See footnote 179.

The Court concluded as a matter of law that under the case of Waggoner v. Laster, 581 A.2d 1127 (Del. 1990), and the current DGCL, “that it may not apply estoppel in this context.  Equitable estoppel may apply ‘when a party by his conduct intentionally or unintentionally leads another, in reliance upon that conduct, to change position to his detriment.’”  In Waggoner, the Supreme Court addressed the stockholders’ equitable argument that a board, which had previously issued preferred stock with super-majority voting rights, should be prohibited under equitable estoppel from contesting the validity of the voting rights, even though there were void from want of authorization in the corporation’s charter.  In conclusive terms, the Supreme Court held that estoppel

“has no application in cases where the corporation lacks the inherent power to issue certain stock or where the corporate contract or action approved by the directors or stockholders is illegal or void.  Neither can a board ratify void stock.  Only voidable acts are susceptible to these equitable defenses.  In brief, because equity cannot directly remedy void stock, neither should equity be able to indirectly remedy void stock.”  See footnotes 186 through 191.

Based on the lack of written instruments and lack of equitable power of the Court to remedy these statutory defects, the Court determined that Mary did not establish her burden and as a result John and Ann were held to be the majority stockholders of the Numoda Corp Class B voting stock.  The Court relied on the presumption that John and Ann were the holders of a majority of the Class B voting stock based on the stock ledger, which shifted the burden to Mary to establish a different ownership structure for Numoda Corp.

Regarding the Numoda Tech’s stock ledger, which was blank, the Court had to look beyond it to determine the shareholders.

The Court determined that all of the stock of Numoda Tech is void.  No Numoda Tech stock had been validly issued and Mary was not able to rebut that position because a Numoda Tech board never approved, by written instrument, any stock issued.

The Court determined that because all the Numoda Tech stock is void, equity was not able to remedy the defect in the context of this case, nor were equitable defenses applicable.  Because the Court concluded that Numoda Tech is a corporation with no stockholders, a written consent of Numoda Tech stockholders based on the proposition that John and Ann were majority stockholders, is invalid.

Regarding the directors of Numoda Tech, it was not disputed that Mary was a director immediately preceding the delivery of the written consent of Numoda Tech stockholders.

The Court explained that DGCL Section 141(b) has been interpreted to allow a director to orally resign and that subsequent actions consistent with an oral resignation can support finding a resignation without written notice.

The Court relied on annual franchise tax reports submitted to the Delaware Secretary of State under oath, as well as related evidence that supports the position that Mary was the sole director of Numoda Tech.  The Court found the testimony that sought to discredit statements in the annual franchise tax which listed Mary as the sole director to be unreasonable and therefore not credible.

The only issues in this Section 225 action were the validity of the written consents to determine the directors of Numoda Corp and Numoda Tech.  In order to make this determination, the Court had to determine whether certain stock was validly issued.

Conclusion
The Court concluded that John and Ann comprised the board of Numoda Corp. because they were found to have a majority of the valid shares of voting stock.  However, the Court concluded that Mary was the sole director of Numoda Tech because John and Ann had previously resigned as directors and Numoda Tech had no validly issued stock.

Postscript: On Nov. 27, 2013, in The Ravenswood Investment Co., L.P. v. Winmill, the Court of Chancery also addressed an issue involving DGCL Section 228, in connection with the date of the signature on the written consent and if the date of the signature complied with the statute.

This post juxtaposes two recent decisions from the Delaware Court of Chancery addressing a perennial favorite of Delaware corporate litigation: Stockholder demands for records under DGCL Section 220.

Although the Section 220 demand was successful in the matter of Donnelly v. Keryx Biopharmaceuticals, Inc., C.A. No. 2018-0892-SG (Del. Ch. Oct. 24, 2019), by contrast:

Section 220 demands were denied in post-trial opinions in the matter of Southeastern Pennsylvania Transportation Authority v. Facebook, Inc., C.A. No. 2019-0228-JRS (Del. Ch. Oct. 29, 2019), and High River Limited Partnership v. Occidental Petroleum Corporation, C.A. No.  2019-0403-JRS (Del. Ch. Nov. 14, 2019).

The Donnelly case, is an example of a successful 220 demand based on the court’s finding of:

(1)       A credible basis to investigate claims of breach of the duty of loyalty; and,

(2)       The rejection of the argument that, contrary to the 2017 Chancery decision in Wilkinson v. A. Schulman, Inc. (highlighted on these pages here), the plaintiff in this matter was a mere proxy for plaintiff’s counsel who was a driving force behind the Section 220 demand, as was the case in Schulman.  The Schulman case was distinguished on its facts.

(3)       The Donnelly decision also provides an excellent overview of the necessary elements, and their “sub-parts”, that must be satisfied to prevail in a Section 220 claim. See Slip op. at 8.

By contrast, the decision in SEPTA v. Facebook, Inc., linked above, added to the long list of examples highlighted on these pages over the past 15 years that, at least in this author’s view, support the observation that Section 220 is a “blunt instrument at best” that requires substantial financial stamina and wherewithal to “go the distance” through trial and potential appeals. This SEPTA case is one of many cases that also support the observation that the results of a Section 220 demand, even when a post-trial ruling requires the production of documents, are often unsatisfying and do not provide an enticing ROI.

In the High River case, after describing Delaware law as “murky” at best, regarding whether the desire to communicate with other stockholders is a proper purpose under Section 220 in all circumstances, the Court of Chancery explained in a 22-page post-trial opinion why this was “not the right case” to announce a bright line rule endorsing such a purpose.

The Delaware Court of Chancery in Kerbawy v. McDonnell, C.A. No. 10769-VCP (Del. Ch. Aug. 18, 2015), addresses whether written consents of stockholders were effective in replacing the board members of the company involved.  The case features the interplay between DGCL § 225 and § 228 in this corporate litigation over control of the company. DGCL § 228 is the provision that allows written consent of stockholders in lieu of a meeting and without prior notice to the minority stockholders.  DGCL § 225 is the provision that allows for summary proceedings on an expedited basis to determine who the proper directors of a company are, for example, when there is a dispute about the results of an election or, as in this case, the validity of written consents of stockholders purporting to remove directors or elect directors, or both.

This case provides a playbook of sorts on how to take control of a board via written consents.

Highlights from 59-page Post-Trial Decision

DGCL § 228(a), unless otherwise provided in the Certificate of Incorporation, allows stockholders to take action by written consent that might otherwise be taken at an annual or special meeting of stockholders.  The written consent is effective “without a meeting, without prior notice and without a vote.”  The written consents must be signed and bear the date of signature of each stockholder who signs the consent.  Action by written consent is effective only if the required number of consents are delivered within 60 days of the earliest date of consent.  See § 228(c).

The court observed that when a majority of stockholders have executed written consents to remove a board, the burden of proving that a director should not be removed or that an election is invalid, rests with the party challenging its validity.  This is a heavy burden, especially in light of “the importance Delaware law places on protecting the stockholder franchise, which has been characterized as the idealogical underpinning upon which the legitimacy of the director’s managerial power rests.”  See footnote 115.

The parties did not dispute the validity of the consents on technical grounds, but rather the argument was made that the court should set aside the otherwise valid consents on equitable grounds, based on allegations that: (1) the consents were based on misleading disclosures; (2) they were based on the misuse of confidential information; and (3) they were procured by tortious interference with an applicable agreement.

Key Principles

  • The court emphasized that a minority stockholder does not owe a fiduciary duty in general nor a duty of disclosure in particular.
  • Although directors of Delaware corporations have a duty to disclose fully and fairly all material information within the board’s control when seeking shareholder action, a party who is neither a director nor an officer, controlling stockholder or member of the control group has no such obligation. The court distinguished cases cited at footnote 118 where equitable relief was available for failure to disclose material facts in soliciting consents.
  • The court explained that: “Just as Delaware law does not require directors-to-be to comply with fiduciary duties, former directors owe no fiduciary duties.”  See footnote 127 (discussing the theoretical basis of the duty of disclosure).
  • But, if the written consents were procured by misleading disclosures, as opposed to the absence of any required disclosure, that fact could support an equitable claim to set those consents aside. One takeaway that a skeptic might extract from this opinion is that consent solicitations might more easily be performed by a person without a fiduciary duty.
  • The court describes the limited scope of a § 225 action and the limited relief available in such an action in light of its status as an in rem proceeding. See footnotes 148 through 149.
  • The court found that the sharing of confidential information that the fiduciary should have not shared was not ideal, but no harm was shown from the sharing of that information such that it would impact the analysis to set aside the written consents on an equitable basis.
  • DGCL § 228 enables stockholders to act independently of the board, and allows them to act without prior notice, and without discussion. By definition, that allows for a “secret compilation of consents” which might otherwise surprise the board when the board members learn of it.
  • In sum, there was no breach of fiduciary duty, fraud or other wrongdoing that “so inequitably tainted the election” for the court to intervene.

 

 

The following article is reprinted with permission from the Jan. 15, 2020 edition of “The Delaware Business Court Insider”, (c) 2020 ALM Media Properties, LLC. All rights reserved.

By: Francis G.X. Pileggi and Chauna A. Abner

This is the 15th year that Francis Pileggi and various co-authors have created an annual list of important corporate and commercial decisions of the Delaware Supreme Court and the Delaware Court of Chancery. This list does not attempt to include all important decisions of those two courts that were rendered in 2019. Instead, this list highlights notable decisions that should be of widespread interest to those who work in the corporate and commercial litigation field or who follow the latest developments in this area of Delaware law. Prior annual reviews are available at this hyperlink.

This list focuses, with some exceptions, on the unsung heroes among the many decisions that have not already been widely discussed by the mainstream press or legal trade publications. Links are also provided below to the actual court decisions and longer summaries.

DELAWARE SUPREME COURT DECISIONS

Company Required to Produce Emails Among Management to Stockholders

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

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

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

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

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

Delaware Supreme Court Clarifies Ab Initio Requirement for BJR Review

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

Much commentary has already been written about this case, so a lengthy summary is not provided here, but I refer to prior decisions that have applied the ab initio requirement, for background purposes, as noted on these pages.

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

Delaware Supreme Court Clarifies Appraisal Law

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

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

Delaware Supreme Court Addresses Independence of Directors

In Marchand v. Barnhil, CA. No. 2017-0586-JRS (Del. Ch. June 18, 2019), the Delaware Supreme Court addressed the meaning of the words “independence” and “disinterestedness” in the context of adequately pleading pre-suit demand futility as a prerequisite for pursuing a derivative claim against corporate directors. The court reversed the Court of Chancery’s dismissal of the case for failure to establish demand futility. This issue is one of the most nuanced and challenging in Delaware corporate litigation as indicated by the disagreement on the outcome among the experienced jurists deciding this case.

https://www.delawarelitigation.com/2019/06/articles/delaware-supreme-court-updates/delaware-supreme-court-addresses-independence-of-directors/

Delaware Supreme Court Instructs on Standards of Deposition Conduct

A recent Delaware Supreme Court opinion provides a tutorial on the standards imposed on Delaware lawyers when a deponent, who is the lawyer’s client, engages in inappropriate conduct during a deposition. In Shorenstein Hays-Nederland Theaters LLC Appeals, Nos. 596, 2018 and 620-2018 (Del. June 20, 2019), Delaware’s High Court issued its first decision on this specific issue, as compared to the rather abundant guidance that has existed for many years regarding the consequences when lawyers themselves engage in errant conduct during a deposition.

https://www.delawarelitigation.com/2019/09/articles/delaware-supreme-court-updates/delaware-supreme-court-instructs-on-standards-of-deposition-conduct/

Confidentiality Agreement Not Always Required for Section 220 Demands

For the first time, the Delaware Supreme Court decided that in a lawsuit in which a stockholder demands corporate books and records pursuant to Section 220 of the Delaware General Corporation Law, although it is typical to condition the production of records on entering into a confidentiality agreement, that the statute does not strictly require such a condition for production. The court also explained in Tiger v. Boast Apparel, Inc., No. 23, 2019 (Del. Aug. 7, 2019), that a party need not show exigent circumstances for a court to grant something less than indefinite confidentiality, and the inspection of records pursuant to Section 220 is not subject to a presumption of confidentiality.

https://www.delawarelitigation.com/2019/08/articles/delaware-supreme-court-updates/confidentiality-agreement-not-always-required-for-section-220-demands/

COURT OF CHANCERY DECISIONS

Chancery Clarifies Director’s Right to Corporate Records

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

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

Chancery Finds Usurpation of Corporate Opportunity

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

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

Chancery Applies Corporate Advancement Case Law to LLC Context

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

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

Chancery Instructs on DGCL Merger Requirements

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

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

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

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

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

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

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

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

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

Chancery Grants Advancement on Counterclaims

A recent decision of the Delaware Court of Chancery clarifies those instances where a defensive counterclaim against a former officer and director may be covered by advancement rights. In a bench ruling in Dodelson v. AC Hold Co., Inc., C.A. No. 2019-009-SG (Transcript) (Del. Ch. May 21, 2019), the court interpreted the charter provision that included within the coverage for “indemnified parties” both former directors and officers. Notably, bench rulings may be cited as authority in briefs before the Delaware Court of Chancery.

https://www.delawarelitigation.com/2019/06/articles/chancery-court-updates/chancery-grants-advancement-on-counterclaims/

Chancery Orders Mandatory Indemnification per DGCL Section 145(c)

The recent Delaware Court of Chancery decision in Brown v. Rite Aid Corporation, C.A. No. 2017-0480-MTZ (Del. Ch. May 24, 2019), clarified the perennial issue of how the word “success” is defined for purposes of mandatory indemnification under Section 145(c) of the Delaware General Corporation Law–even if all of the arguments in the underlying litigation were not successful.

https://www.delawarelitigation.com/2019/06/articles/chancery-court-updates/chancery-orders-mandatory-indemnification-per-dgcl-section-145c/

Chancery Determines Valid LLC Managers; Rejects Bump-Out Theory of Board Replacements

The Delaware Court of Chancery left no doubt in a recent ruling that the “bump-out theory” of replacing LLC managers is not recognized in Delaware. In Llamas v. Titus, C.A. No. 2018-0516-JTL (Del. Ch. June 18, 2019), the court explained that incumbent managers need to be removed before their replacements can validly “take their seats.” The court interpreted the counterpart to DGCL Section 225, which is Section 18-110(a) of the Delaware LLC Act.

https://www.delawarelitigation.com/2019/07/articles/chancery-court-updates/chancery-determines-valid-llc-managers-rejects-bump-out-theory-of-board-replacements/

Advancement Granted for Post-Termination Use of Confidential Information

A recent Delaware Court of Chancery opinion in Ephrat v. medCPU, Inc., C.A. No. 2018-0052-MTZ (Del. Ch. June 26, 2019), will remain a noteworthy decision for two reasons: (1) It provides and anthology of prior Delaware decisions granting advancement to former directors or officers that defend claims regarding the use of confidential information acquired in a prior corporate capacity; and (2) It adds nuance to the existing abundant case law interpreting the threshold phrase “by reason of the fact,” which is one of the statutory prerequisites that must be satisfied for advancement claims to prevail pursuant to DGCL Section 145.

https://www.delawarelitigation.com/2019/07/articles/chancery-court-updates/advancement-granted-for-post-termination-use-of-confidential-information/

Chancery Addresses Personal Jurisdiction Over Co-Conspirator

In Clark v. Davenport, C.A. No. 2017-0839-JTL (Del. Ch. July 18, 2019), the court provided a noteworthy explanation of the important nuances that need to be understood when personal jurisdiction is contested, and this opinion provides an excellent analysis of the requirements for opposing personal jurisdiction based on the Delaware Long Arm Statute.

https://www.delawarelitigation.com/2019/08/articles/chancery-court-updates/chancery-addresses-personal-jurisdiction-over-co-conspirator/

Fully-Executed Contract Ruled Unenforceable

In Kotler v. Shipman Associates, LLC, C.A. No. 2017-0457-JRS (Del. Ch. Aug. 21, 2019), the Delaware Court of Chancery issued an opinion that should be read by all lawyers who seek to avoid the risk of a fully-executed contract being ruled unenforceable due to a court later finding, perhaps surprisingly, that the agreement did not accurately express the understanding of the parties.

https://www.delawarelitigation.com/2019/08/articles/chancery-court-updates/fully-executed-contract-ruled-unenforceable/

Chancery Explains Step-Transaction Doctrine and Defines “Affiliate”

An important concept known as the step-transaction doctrine, which treats the agreements 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, was explained in the recent Delaware Court of Chancery opinion in PWP Xerion Holdings III LLC v. Redleaf Resources, Inc., C.A. No. 2017-0235-JTL (Del. Ch. Oct. 23, 2019) and should be consulted by anyone who needs to understand the components of this important doctrine.

https://www.delawarelitigation.com/2019/10/articles/chancery-court-updates/chancery-explains-step-transaction-doctrine-and-defines-affiliate/

Delaware Forum Selection Clause Controls Over Foreign Exclusive Jurisdiction Statute

The recent Delaware Court of Chancery decision in AlixPartners, LP v. Mori, No. 2019-0392-KSJM (Del. Ch. Nov. 26, 2019) rejected an effort to dismiss a Delaware action notwithstanding the provision in an agreement that provided for a forum in a foreign country, and the apparent law of that foreign country that also supported exclusive jurisdiction in that country.

https://www.delawarelitigation.com/2019/12/articles/chancery-court-updates/delaware-forum-selection-clause-controls-over-foreign-exclusive-jurisdiction-statute/

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

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

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

DELAWARE SUPREME COURT DECISIONS

Delaware Supreme Court Clarifies Appraisal Law

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

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

Company Required to Produce Emails Among Management to Stockholders

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

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

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

Brief Overview:

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

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

Highlights of Key Aspects of the Court’s Ruling:

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

Procedural Background:

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

Basic Principles:

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

Emails/ESI Production:

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

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

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

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

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

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

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

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

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

Delaware Supreme Court Clarifies Ab Initio Requirement for BJR Review

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

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

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

Supreme Court Affirms Akorn Decision

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

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

COURT OF CHANCERY DECISIONS

Chancery Instructs on DGCL Merger Requirements

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

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

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

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

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

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

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

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

Key Highlights of Decision:

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

DGCL Section 262:

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

DGCL Section 228:

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

DGCL Section 228(e)–Prompt Notice Requirement:

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

DGCL Section 251(b):

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

DGCL Section 144:

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

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

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

Chancery Applies Corporate Advancement Case Law to LLC Context

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

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

 Brief Background:

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

 Issues Addressed:

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

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

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

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

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

Chancery Finds Usurpation of Corporate Opportunity

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

Basic Background Facts:

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

Key Principles of Law:

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

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

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

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

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

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

Slip op. at 36-38.

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

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

Key Reasoning of the Court:

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

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

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

Chancery Clarifies Director’s Right to Corporate Records

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

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

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

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

Advancement for Counterclaims Granted Despite Withdraw of Covered Claim

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

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

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

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

Chancery Addresses “Commercially Reasonable Efforts” Standard

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

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

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

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

Key takeaways:

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

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

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

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

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

Overview of Key Points:

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Key Highlights of Decision:

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

DGCL Section 262:

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

DGCL Section 228:

·     Based on an amendment to the statute passed in 2017, Section 228 no longer requires that the written consent of stockholders be dated next to each signature.  See Slip op. at 19. 

·     The court addressed the “less than bright-line rule” about whether or to what extent disclosures are required in connection with written consents of stockholders pursuant to Section 228, but cases cited by the court in this opinion support the view that in this case the company is not entitled to judgment on the pleadings on this issue in light of the lack of material data, or their supplying of incorrect data, with the solicitations for consents that were sent to the minority stockholders in this case.

DGCL Section 228(e)–Prompt Notice Requirement:

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

DGCL Section 251(b):

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

DGCL Section 144:

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

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

The Delaware Court of Chancery recently addressed the challenged removal of an LLC manager and the validity of written consents. In Godden v. Franco, C.A. No. 2018-0504-VCL (Del. Ch. Aug. 21, 2018), the court explained several important principles that the Delaware courts use to analyze issues in the LLC context and interpretive rules involving LLC agreements.  In the process, the court provided a helpful analysis of the equitable powers of the court to fashion remedies in the context of an LLC notwithstanding the often exaggerated explanation of LLCs as creatures of contract.  For example, the court cited recent scholarship from Professor Mohsen Manesh that explains why LLCs are not wholly contractual and should be described as “only partially creatures of contract.” See Mohsen Manesh, Creatures of Contract: A Half-Truth about LLCs, 42 Del. J. Corp. L. 391 (2018)(noted on these pages.) The court also cites to other exceptions to the exaggerated concept of the LLC as merely a creature of contract. See pages 15-17 and footnotes 16-22.

Other Highlights:

  • An essential point in the court’s analysis is that if an LLC Agreement and the LLC Act do not address an issue, then Section 18-1104 of the Delaware LLC Act reverts to equity and rules of law for resolution. See footnotes 17-19 and accompanying text.
  • The court provides basic contract interpretation principles at page 17 of the slip opinion. An important principle in both the LLC context and the corporate context is articulated as follows: A contract provision that “tends to induce” the violation of a fiduciary duty is not enforceable on grounds of public policy. See footnote 43 and accompanying text.
  • A statement of law that has widespread application in the corporate and commercial context is that under Delaware law, corporate separateness is a bedrock principle. See Slip op. at 25.
  • The court also provided an helpful analysis and a comparison of written consents in different contexts. Specifically, Section 18-404(d) of the LLC Act allows non-unanimous written consents of managers of LLCs, similar to DGCL Section 228(a) for corporate stockholders—but contrariwise, DGCL Section 141(f) requires unanimous written consent for corporate board action.

The Ravenswood Investment Company, L.P. v. Winmill, C.A. No. 3730-VCN (Del. Ch. Nov. 27, 2013).

Issue Addressed:  The statutory requirements under DGCL Section 228 for a written consent of stockholder in lieu of meeting, and a written consent of director in lieu of meeting pursuant to DGCL Section 141. (N.B. After the date of this opinion, DGCL Section 228 was amended to address the date requirement discussed in this decision.)

Brief Overview:

The procedural and factual background of this case was highlighted on these pages in connection with prior decisions in this matter.

DGCL Section 228(c) provides that every written consent shall bear the date of the signature.  The issue in this case was that the date was preprinted and was preceded by the words “as of.”  There was no factual dispute however, that the signature was provided on that same date.  The Court distinguished the Wexford case which involved signatures of shareholders which bore the same date but which in realty were not all signed on the same date.

In essence, the Court reasoned that because there was no factual question that the signature of the stockholder was made on the date typed on the form, it complied with the requirement of Section 228.  By contrast, the Court noted, that the written consent of a director in lieu of a meeting is not required to be dated pursuant to DGCL Section 141(f).

PRACTICE POINTER:  The Court provides advice to practitioners that the better practice would be to place a separate date next to each shareholder signatory on a written consent pursuant to Section 228(c) which would thereby avoid issues that arose in this case.  But where, as here, there is no uncertainty as to the date that the signature was made and that is the same date stated on the written consent, the statute is satisfied.  (N.B. After the date of this opinion, DGCL Section 228 was amended to address the date requirement discussed in this decision.)

The Court also addressed a separate and unrelated issue about whether discovery of documents should be produced in original “native format.”  The Court relied on prior case law to explain that unless there is a “particularized showing of need,” there is no general requirement that documents be produced in their “native file format including metadata.”  See footnote 16 and accompanying text.

Carsanaro v. Bloodhound Technologies, Inc., C.A. No. 7301-VCP (Del. Ch. March 15, 2013).

This 76-page Chancery decision addresses issues that include the following: (1) when a claim for dilution of minority shares can be pursued directly instead of, or in addition to, derivately; (2) restrictions imposed by DGCL Section 160 on the right to redeem shares; (3) prerequisites of DGCL Section 228 that allows for written consent in lieu of a shareholder meeting; (4) when equitable tolling due to fraudulent concealment will bar a laches defense; (5) what must be pled to overcome the BJR presumption; and (6) a reminder that there is no safe harbor where dual directorships present divided loyalties.

For the busy reader that is pressed for time and does not want a summary that approaches the 76-page length of this opinion, I offer a few bullet points.

  • One of the most noteworthy aspects of this opinion, that is chock-full of Delaware corporate law bedrock principles, is the discussion at pages 61 and 67 that addresses the important procedural nuance of when a claim against the board of directors for breach of fiduciary duty may be brought directly and/or derivately. The court acknowledges that the case law on this topic may not always be easy to apply in deciphering where the dividing line is for those matters that must  be brought derivately or directly–or which claims can be brought in either procedural posture.
  • The court explains that an individual claim challenging a self-interested stock issuance may be made when the allegations support an actionable claim for breach of the duty of loyalty, as in this case involving somewhat egregious dilution of the minority who were also co-founders. (However, it must be emphasized that this was a ruling on a motion to dismiss and no claims have been proven yet.) Other examples are also included.
  • A purported written consent of shareholders allegedly pursuant to DGCL Section 228 was not effective because the exhibit which was referred to in the consent was not provided for over a month after the consent was signed, despite a request. See Slip op. at 27-28.
  • A overview of basic principles of what must be pled to overcome the business judgment rule presumption is provided at pages 19 and 20 (e.g., at least half the board must be shown to be lacking in independence or disinterestedness), and a useful reminder is provided to explain when the burden of proof will shift to establish the entire fairness of an interested transaction.
  • The court emphasized that the right to redemption under DGCL Section 160 is not without limitation.
  • Another reminder in the opinion is that corporate actions will be “twice tested”: once by the strictures of the DGCL and again by the standards of equity.
  • There is much else to commend this scholarly work for its careful treatment of the issues referenced above. Aside: The court’s equitable heartstrings seem to have been struck based in part on the detailed factual allegations that demonstrated the unfair treatment of the minority whose interests in the company were rudely diluted.

Supplement: Max Kennerly provides interesting commentary about this case and the more general situation where venture capitalist force-out or dilute the founders of a start-up, as well as the need for those founders to have their own lawyers at every step of the process dealing with venture capitalists.