The practical problem of proving a breach of fiduciary duty without being able also to prove damages was recently addressed by the Delaware Court of Chancery in a post-trial opinion styled The Ravenswood Investment Company, L.P. v. The Estate of Bassett S. Winmill, et al., C.A. No. 3730-VCS (Del Ch. Mar. 22, 2018). Several of the many prior decisions in this matter over the last decade have been highlighted on these pages and provide factual and procedural history. In this short blog post, I’ll highlight the key points that may be most useful for those interested in the nuances of corporate and commercial litigation discussed by the court in this decision:

Standard of Review Applicable

  • The challenged executive compensation decisions of the board were subject to the entire fairness test. The presumption of the business judgment rule’s applicability was rebutted because the defendant directors stood on both sides of the transaction. See, e.g., cases cited at footnote 125. Thus, the directors needed to establish both fair dealing and fair price in connection with the challenged compensation decisions.  The 68-page opinion analyzes the interfacing between the two parts of the test. See, e.g., cases cited at footnote 161. The court found that the board failed the entire fairness test, and that they breached their fiduciary duty of loyalty.
  • Although in the past the company had traded on NASDAQ, a father and his two sons constituted the entire board and they alone voted on their own compensation including the disputed stock options. They did not use a compensation consultant and the documentation relating to the “process” and analysis supporting their compensation was, in the court’s description: “thin”. Some of the options exercised were paid with promissory notes that were later forgiven.

Remedies Available

  • The court found no evidentiary basis for compensatory damages, despite finding a breach of the duty of loyalty in connection with the compensation decisions relating to the stock options. See footnote 174 and accompanying discussion.
  • The court considered rescission, rescissory damages, equitable rescission and “cancellation” of the stock options (and the nuanced comparison with that concept and rescission.) The court also grappled with the doctrinal dissonance of fashioning a practical and fair remedy in the context of a derivative action when the corporate benefit would be enjoyed to a large extent by the defendants who are major stockholders, for example. See, e.g., footnotes 180 to 188.
  • Nominal damages, in the end, were the only damages that the court determined to be available under the circumstances of this case. See footnotes 215-216.
  • Notably, the court acknowledged that the plaintiff was still requesting attorneys’ fees and that it would consider that issue separately. There is precedent in Delaware for a court to award attorneys’ fees when there has been a breach of fiduciary duty but no measurable damages. See, e.g.,William Penn Partnerships v. Saliba, C.A. No. 111 (Del. Supr. Feb. 9, 2011), highlighted on these pages here. The award of attorneys’ fees in such a situation may be slim solace for the plaintiff, and of primary interest to the lawyers, but at the very least it “levels the field” somewhat to the extent that if the plaintiff is not “in the hole” for any attorneys’ fees, then that plaintiff is not disadvantaged by bearing the cost of proving the defendants’ breach of fiduciary duty.

A recent Delaware Court of Chancery transcript ruling is notable for stating that there is no per se affirmative obligation, absent a request for stockholder action, in a closely held company, to produce financial statements. The court held, however, that under certain circumstance, for example in response to a demand under DGCL Section 220, it could raise a fiduciary duty question if no financial statement were prepared in order to keep the minority “in the dark.” The Ravenswood Investment Company, L.P. v. Winmill & Co. Inc., C.A. No. 7048-VCN (Transcript) (Del. Ch. Feb. 25, 2016). Note that transcript rulings are often cited as “good authority” in Delaware briefs (and formal court opinions.)

The short transcript ruling follows many other decisions in this long running dispute between the parties, and some of those prior Delaware rulings have been highlighted on these pages. Three statements of law that are helpful for purposes of those engaged in Delaware corporate and commercial litigation can be summarized as follows:

1)         There is no duty per se to provide financial statements in a closely-held company when stockholder action is not being requested. See Slip op. at 7.

2)         Based on the facts of this case, the court did allow a claim for breach of fiduciary duty based on the allegation that no financial statements were provided or even created as a means of thwarting a pending Section 220 claim and “keeping the stockholders in the dark.”

3)         The court allowed an amendment to a complaint in a case that appears to have been languishing for several years although the transcript does not elaborate on the potential justification for that situation transpiring.

SUPPLEMENT: Keith Bishop on his California Corporate and Securities Law blog, comments on this case by noting that despite Delaware law, if a Delaware company has its main office in California or regularly holds board meetings there, it may be required to produce annual reports pursuant to California law.

SUPPLEMENT II: The estimable Professor Stephen Bainbridge provides scholarly insights about this decision with citations to authorities and learned commentary.

The Ravenswood Investment Company, L.P. v. Winmill & Co. Incorporated,
C.A. No. 7048-VCN (Del. Ch. Dec. 31, 2014). This Chancery ruling limited the number of years that documents produced pursuant to DGCL Section 220 would need to be kept confidential. In addition, the court rejected the request that the receiving party indemnify the company for any violation of law committed by the receiving party which related to the use of the documents produced.

This decision did not cite to the Delaware Supreme Court’s Treppel decision of a few days earlier, highlighted on these pages, in which the high court allowed a forum selection requirement to be imposed as a pre-condition of producing records under Section 220. Prior Chancery decisions in this case were highlighted on these pages.

This is yet another example of how Section 220 cases, despite the apparent simplicity of the statute, can become protracted and expensive endeavors. Section 220 actions often prove to be neither for the faint-hearted nor for those with meager financial stamina.

The Ravenswood Investment Company, L.P. v. Winmill & Co. Incorporated, C.A. No. 7048-VCN (Del. Ch. May 30, 2014).

This Court of Chancery decision is noteworthy because it addresses for the first time the issue of whether the production pursuant to DGCL Section 220 of books and records can be conditioned on the agreement by the stockholder not to trade in the stock of a defendant company that is thinly traded over-the-counter. The answer is: NO. The company was concerned about “tipper” liability under the federal securities laws, but nothing in this decision should be interpreted to absolve either the company or the stockholder of any liability as a tipper or a tippee.

Also important is the reiteration of a truism in defense of Section 220 cases that allows a company to deny a request if they can establish that the stated purpose is not the actual purpose, and that the actual purpose is improper. See footnote 26, citing Pershing Square, L.P. v. Ceridian Corp., 923 A.2d 810, 817 (Del. Ch. 2007) (“A corporate defendant may resist demand where it shows that the stockholder’s stated proper purpose is not the actual purpose for the demand. . . . [T]he defendant must prove that the plaintiff pursued its claim under false pretenses, and its primary purpose is indeed improper.”).

This decision also features the court’s analysis that statements by an attorney to the court on behalf of a client regarding what issues are still open for the court to decide, will be binding on the client. In this context, that court bound the company to its lawyer’s statement that the only open issue for decision was the condition on the production that would limit trading.

Lastly, the court explained why it declined a request to impose attorneys’ fees for allegedly bad faith litigation tactics, and included a reminder that Section 220 cases should not include other claims, (i.e., should be limited to Section 220 claims.)

Editor’s Note: This case is another example of how a seemingly simple statute like DGCL Section 220 regarding the right of a stockholder to obtain certain books and records if it can satisfy certain prerequisites, continues to spawn many decisions about various nuances of the statute that are still not quite clear despite hundreds of court opinions interpreting the statute–and how expensive these suits can be for stockholders pursuing them.

Supplement: Several prior Delaware decisions between these parties have been highlighted on these pages.

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.

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.

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.

The Ravenswood Investment Company, L.P. v. Winmill & Co., Inc., C.A. No. 7048-VCN (Del. Ch., Jan. 31, 2013). Issue Addressed: Whether a fiduciary duty claim can be combined with a Section 220 claim in the same complaint.   Short Answer: No.

Brief Summary

This case involved a complaint that sought relief under DGCL Section 220 and also asserted fiduciary duty claims based on the argument that the board of directors of Winmill withheld information for the purpose of suppressing the stock price, resulting in the reluctance of investors to acquire shares in a company that refuses to disclose information.  The argument was that such a lowered stock price would give insiders an opportunity to acquire a greater percentage of ownership in the private company at a lower price.

This letter opinion begins with a thoughtful observation that is applicable to virtually every litigated matter:

“Sometimes disputes that arise during the course of litigation can be resolved by resort to grand principles.  Sometimes a practical approach offers a better option for moving the matter along.  The current disagreement seems to fall in the latter category.”

The Court observed that a Section 220 action is intended as a summary proceeding, and a companion fiduciary duty claim would slow the pace.  Therefore the two claims should not have been brought together.  See footnote 4.

The Court also addressed the somewhat unique aspects of limited discovery in a Section 220 case, which is very narrow in purpose and scope and is typically very limited as it relates to the corporate defendant.  Nonetheless, in this case the Court allowed the functional equivalent of a Rule 30(b)(6) deposition of a corporate designee and depending on the results of that deposition, allowed for the possibility of the plaintiff deposing members of the board of directors of the corporate defendant, in order to inquire about why the defendant was insisting as a condition of producing documents that the plaintiff not trade on the information that it received and otherwise to inquire into the reluctance of the corporate defendant to produce records based on their concern about what the plaintiff might do if it received the non-public corporate financial information.

In support of this inquiry, the Court stated that if the corporate defendant refused to produce its directors for deposition on this issue, those corporate directors would not be entitled to testify at trial.

See generally two prior Chancery decisions between these parties highlighted on these pages.

The Ravenswood Investment Company L.P. v. Winmill, C.A. No. 3730-VCN (Del. Ch. Nov. 30, 2011), read letter ruling here. A prior decision by the Delaware Court of Chancery in this case was highlighted on these pages here.

Issue Addressed

The Court addressed a motion for reargument under Rule 59(f), as well as Court of Chancery Rule 59(e), to alter or amend the Court’s prior memorandum opinion of May 31, 2011.

Brief Overview

The three arguments made regarding the Court’s prior opinion were as follows: (i) The prior decision contained a material mathematical error; (ii) The allegations in the complaint should form a basis to give the plaintiff an opportunity to amend its complaint in order to expand on the original allegations; and (iii) Ravenswood argues that the complaint did contain sufficiently particularized allegations that established demand futility.

The Court addressed the standard to be applied under Rule 59(e) for a motion to alter or amend a judgment based on three prerequisites:  (i) an intervening change in controlling law; (ii) the availability of new evidence not previously available; (iii) a need to correct a clear error of law or prevent manifest injustice.

By contrast, under Rule 59(f) a motion for reargument may be granted if the moving party demonstrates that the Court’s decision was predicated upon a “misunderstanding of a material fact or a misapplication of the law.”

Although the Court made a mathematical error in footnote 50, it was not a material error.  The Court explained that any stock options involved would have a dilutive effect on shareholders’ equity and this effect alone does not render an options plan unfair.  See footnotes 19 and 20.  Thus, the Court refused to revisit its dismissal of the claim that the defendants breached their fiduciary duties by adopting a stock option plan.  The Court also refused to reconsider the argument that demand should have been excused with regard to the claim regarding a stock buyback plan allegedly harming Winmill.

The Ravenswood Investment Company, L.P. v. Winmill, C.A. No. 3730-VCN (Del. Ch. May 31, 2011).

Brief Overview

This case involved a plaintiff who is a significant stockholder in a holding company managed by the individual defendants, a father and his two sons.  The complaint alleges breaches of fiduciary duty regarding the adoption of a stock buyback plan, the adoption of an options plan, the issuance of options to themselves, and the decision by the company to vote in favor of a transaction involving the sale of the interest of a subsidiary in a third entity.  This memorandum opinion grants in part and denies in part a motion to dismiss.  The Court only denied a motion to dismiss to the extent that the Court allowed a claim to proceed regarding the vote of the defendants in favor of the sale of an interest in an affiliated third entity that was alleged to be both self-interested and unfair to the company.

Brief Overview of Legal Analysis

First, the Court reviewed the familiar standard for a motion to dismiss under Court of Chancery Rule 23.1 based on the two-pronged test of Lewis v. Aronson to determine whether presuit demand was excused.  See 473 A.2d 805, 814 (Del. 1984).  The Court also discussed the separate analysis under Rule 12(b)(6) for a motion to dismiss for failure to state a claim. 

(1) Adoption of Stock Option Plan

The Court observed the well-known deference that applies to compensation decisions by a company for its executives but also recognized the exception where the individuals comprising the board and the management of the company are the same as those receiving the compensation. In those instances, the board bears the burden of proving that the salary and bonuses they pay themselves are entirely fair unless the board employs an independent compensation committee or submits the compensation plan to shareholders for approval.  See footnote 44.  Neither safeguard was employed here, and therefore, the defendants had the burden of demonstrating that the stock option plan was entirely fair to the company and its shareholders, although the plaintiff bears the burden of alleging facts that suggest the absence of fairness.  See footnote 45.

The plaintiff here alleged that defendants adopted the stock option plan with the intention to acquire a larger percentage of the shares of the company in order to dilute the public shareholders’ equity.  Of course, the Court cited to other decisions holding that an options plan is not necessarily unfair simply because it has a dilutive effect on shareholders’ equity.  Moreover, the motion to dismiss in this case did not seek dismissal of the claims regarding the issuance of the options, and therefore, the Court did not need to address the dilution claim.  However, a problem for the plaintiff in this case was that it did not allege facts suggesting unfairness in adopting the options plan because even if all the options were exercised the defendants would not obtain a majority, and therefore, the Court dismissed the claims challenging the adoption of the plan–as opposed to the issuance of the options.

(2) Claims Regarding the Adoption and execution of a Stock Buyback Plan

The Court regarding these claims as derivative  in nature, and interpreted the claims as challenging the buyback plan in terms of either: (i) diminishing the value of the company, or (ii) reducing the proportional ownership of the public shareholders.  However, the Court found that the plaintiff did not allege with sufficient particularity facts indicating that the defendants were interested parties to the stock buyback plan or that the decision to engage in the buyback program was not the product of a valid business judgment.  In sum, the Court could not discern any “particularized allegation that would excuse Ravenswood from making demand with regard to this plan.”

(3) Sale by Company of its Interest Affiliate

The plaintiff challenged the approval by the company, as a 22% shareholder in an affiliate, of the sale of the affiliate’s 50% interest in a company called York and the acceptance by two directors of the company of separate compensation in connection with that sale.  The allegation is that the acceptance of that compensation tainted the decision of the company to vote its shares in favor of selling the interest that the company owned in the affiliate.  The Court discussed whether those claims were direct or derivative and whether the derivative claims survived the motion to dismiss under Rule 23.1. 

Because two of the three directors involved had a “material, disqualifying self interest” when they voted the shares of the company in favor of the sale of York, the claims did survive a motion to dismiss under Rule 23.1.  Likewise, the claims survived a motion to dismiss under Rule 12(b)6 because the allegations in the complaint were that the compensation was wrongfully paid to the directors in connection with the transaction which resulted in a benefit to the company from the transaction being smaller than it should have been.