Delaware Corporate Law Update

Updates on Delaware Corporate Law by Evan O. Williford, Esq., Delaware Corporate Litigation Attorney.

Chancery and Practitioners Give Tips On Practice Before Court

On May 22, the annual Recent Developments in Delaware Corporate and Alternative Entity Law seminar was held.  Panels spoke on corporate law blogs, recent developments, and legal ethics.  One panel of particular note spoke on the Court of Chancery’s Guidelines to Help Lawyers Practicing in the Court of Chancery, which were made public in January of this year and are available here.  The panel included several practitioners — Gregory Williams of Richards Layton, Kevin Brady of Eckert Seamans, and Kevin Shannon of Potter Anderson — as well as Chancery Leo E. Strine, Jr.

The Guidelines are almost 18 pages (single-spaced); full of useful guidelines and tips on various situations that regularly come up before the Court.  Anyone practicing before that Court would do well to read, and re-read, them.

One dilemma is that the Guidelines state they are not to be cited as authority to the Court; but the panel clarified that they may be discussed and shared with opposing counsel.  I myself have seen this happen on a number of occasions given the breadth of the Guidelines.

Chancellor Strine noted that a similar set of guidelines concerning discovery is currently in the works , although there is no word on when that will be out.

The panel clarified that the best practice is to submit compendiums that include only key cases and authorities, whether or not they are “nonpublic” (i.e. only available on Lexis/Westlaw).  While Court of Chancery Rule 171(h) calls for all unreported decisions to be included, the increasing general availability of Lexis/Westlaw has taken away the original reason behind the rule, and the Guidelines hinted that including only key authorities was the better way to go.

Other interesting tidbits from the panel:

  • A practitioner should touch and feel anything that is going to the Court.  It is one thing to intellectually instruct that a filing be put together, it is another to look through it and see whether that has been done correctly and if it has whether it would be confusing or cumbersome for the courts. As an example, in a recent set of courtesy copies to the Court from a reputable Delaware firm every fifth word was garbled.  Even a quick look-through would have immediately identified the problem.
  • Delaware practitioners should be prepared to discuss anything filed with the Court with their name on it, even if they are in a Delaware counsel role to another, more active, out-of-state firm.
  • The senior Delaware attorney on the case should be involved in everything that is submitted to the Court.
  • The senior Delaware attorney need not of course be involved in every aspect of discovery, but should be involved (on both sides) in discovery disputes before they need to be submitted to the Court.  It often happens that the Court gets a laundry list of complaints about responses to discovery, a position that the Court would rather not be in.  One panelist also suggested that based upon recent decisions the Court seemed to be getting more restrictive in applying the attorney-client privilege.
  • Chancellor Strine expressed the view that he often found helpful demonstratives that somehow tied together information from a number of exhibits in a useful form, such as a chronology.
  • And finally, for those considering submitting expedited requests for action around August, keep in mind that the Court’s clerks (who typically serve one-year terms) typically turn over at that time.

Filed under: Court of Chancery

Court of Chancery Rejects Summary Judgment As To Loyalty Claims Against VC Investors

Today the Court of Chancery released a memorandum opinion (available here) rejecting much of defendants’ summary judgment motion in a case brought by a unitholder in a Delaware LLC against two venture capital firms and/or their affiliates that had collectively acquired control of the LLC.  By way of disclosure, this firm represents plaintiffs in the litigation.

Plaintiff is a unitholder and former CEO of Adhezion Biomedical LLC, who challenged a series of issuances of preferred units and other rights to defendants including two venture capital firms/affiliates of those firms, Originate Ventures, LLC and Liberty Advisors, Inc.  Plaintiff claimed that the issuances breached defendants’ duties of care and loyalty and obligation of good faith, and violated provisions in the LLC Agreement requiring a class vote by common unitholders.  The Court granted summary judgment as to the duty of care and obligation of good faith claims, but denied it as to plaintiffs’ claims for breach of the duty of loyalty and based upon the class vote requirement.

Noteworthy sections of the Court’s ruling included the following:

  • The Court found a genuine issue of material fact as to whether the two VC firms and their affiliates should be treated as a group for purposes of imposing controlling stockholder duties upon them.  The two VC firms and their affiliates collectively owned more than 66% of the voting units, controlled two of five directors, and had parallel economic interests, and plaintiff identified multiple communications supporting an inference that they exerted actual control of capital raising activities.
  • The Court rejected defendants’ argument that director approval immunized the transactions based upon a provision in the LLC Agreement similar, but not identical, to Section 144 of the Delaware General Corporation Law.  In addition to noting other material factual disputes, the Court ruled that, as a matter of law, in any event it would not operate as a safe harbor against review of the challenged transactions for breach of the duty of loyalty under the entire fairness standard of review.

Filed under: Controlling Stockholder, Court of Chancery, Derivative Actions, Fiduciary Duties

Court of Chancery Posts Practitioner Guidelines

Last week the Court of Chancery posted a document on its website entitled “Guidelines to Help Lawyers Practicing in the Court of Chancery” (available here).  It is intended as a “practice aid” to “minimize disputes over process”.  The document is 18 pages single-spaced, and is required reading (and re-reading) for anyone who practices before the Court, either regularly or occasionally.  Up front the Guidelines state  that they are a practice guide only and are not intended to be “used as a sword” or even cited before the Court.  The Guidelines were announced by press release which itself has some interesting things to say (available here).  Sample forms available with and referenced by the Guide are available here.

The press release reveals that the Court is proposing a rule to eliminate the requirement that a compendium of unpublished cases be provided with submissions, in favor of an “encouragement” to provide only authorities that are crucial to determining the case.  In this age of Westlaw and LexisNexis, along with the number of unpublished Chancery decisions available on the internet, this previous requirement now seems antiquated and the proposed rule a welcome nod to present realities.

A selection of notable comments in the Guidelines:

  • PDAs, blackberries, and cell phones — These are to be turned off and placed in the vestibules outside each courtroom.  If needed for scheduling purposes they may be retrieved and used should the Court permit.
  • The Guidelines repeat the expectations that the Court has previously voiced many times for Delaware counsel, that while it understands that sometimes the division of labor is weighted heavily in favor of forwarding counsel, ultimately it is the “Delaware lawyer who is taking the positions set forth therein and making the representations to the Court,” and this role “does not alter the Delaware lawyer’s responsibility for the positions taken and the presentation of the case.”  Submitting a letter from co-counsel to the Court with a short cover letter is not permissible.
  • The Guidelines list requirements for transmittal letters accompanying courtesy copies of briefs.
  • Counsel calling chambers to seek  potential dates from the Court should only do so with all other counsel on the line or after obtaining authority from them, .  If  potential dates, counsel should relay all of them to the other parties and ensure that information has been shared fairly, even if that attorney is not available for one or more of the dates provided.
  • Except for motions to expedite, scheduling disputes should be resolved by motion, not letter.
  • The Court does not want a lengthy exchange of letters: after a response and possibly a reply letter it is  “time to schedule a conference.”
  • The Court strongly expressed its preference for limited expert discovery (i.e. materials provided to or relied upon by the expert), and that it “understands the degree of involvement counsel typically has in preparing expert reports”.
  • The Court prefers that defendants who wish to oppose a motion to amend on grounds that the amendment would be futile stipulate to the motion but reserve their right to challenge the pleading via answer or motion to dismiss.
  • A submission of fifteen pages or less should be submitted as a speaking motion; a submission of greater length should be a brief with tables of contents and authorities.
  • Discovery disputes — The Court will “not be inclined” to hear arguments — or even authorities — that had not previously been presented to the other side.  “If the argument or authority had been presented, perhaps the dispute would have been resolved.”

Among the forms listed is a lengthy sample scheduling order for a plenary action (available here). It stipulates that many dates not affecting the Court’s schedule may be amended by agreement of the parties, without Court approval.  As has become common before the Court, simultaneous opening and answering pre-trial briefs are contemplated.

Filed under: Court of Chancery

Chancery Zaps Controlling Stockholder For $1.2B In Damages

On Friday, now-Chancellor Leo E. Strine Jr. issued a lengthy post-trial opinion, In re Southern Peru Copper Corp. Shareholder Derivative Litigation, available here, in which he required a controlling stockholder to return $1.2B in stock in connection with a transaction between it and a corporation it controlled.  The case has a number of details of interest to those who advise as to or litigate such transactions or otherwise have an interest on Delaware corporate law.

Controlling stockholder Grupo Mexico ultimately owned about 54% of the stock of Southern Peru Copper Corp. stock and almost all of Minera Mexico’s.  Each of Cerro Trading Company, Inc. (owned in turn by the Pritzker family) and Phelps Dodge Corporation owned about 14% of Southern Peru, although such shares were unregistered and could not easily be sold under federal securities laws.

Grupo Mexico proposed to Southern Peru’s board of directors that the latter buy the former’s shares in Minera Mexico in exchange for approximately $3 billion in Southern Peru stock.  While Southern Peru’s stock was publicly traded, allowing a ready calculation of its value, Minera Mexico’s was not.

Southern Peru formed a special committee of four directors to evaluate the proposal.  The Special Committee hired Latham & Watkins as legal, and Goldman Sachs as financial, advisor (among others).  The Special Committee did not lack for credentials and included a Columbia Law grad who had worked at Wachtell Lipton, a Ph.D. in finance from the Wharton School, and another individual with both an MBA and a JD who had managed multi-billion dollar companies.  The most active member, Harold Handelsman, was an attorney for the Pritzker family.

After several months of due diligence Goldman Sachs concluded in an “Illustrative Give/Get Analysis” presented to the Special Committee that Southern Peru was being asked to “give” stock with a market price of $3.1B to “get” an asset worth no more than $1.7B.  The Special Committee was not specifically given the mandate to negotiate the deal but did so anyway.  It made a counterproposal (not reported in the proxy statement) to issue about $2B of Southern Peru stock.  Grupo Mexico eventually proposed to acquire $2.76B in shares.  Ultimately Goldman Sachs issued a fairness analysis and opinion and the Special Committee agreed to recommend the revised proposal to the board.

The Court criticized the Special Committee for operating “in the confined mindset of directors of a controlled company” and not proposing other alternative transactions to Grupo.  The Court acknowledged that Grupo Mexico could always veto such transactions but suggested that it would have been a positive factor in the legal analysis.

According to the Court, after Grupo Mexico stood pat on its demands, the Special Committee and Goldman Sachs adopted a number of arguments to get to the desired result that the transaction was fair, each of which the Court rejected (including an early argument, later abandoned, that Southern Peru’s stock price did not represent that stock’s real value).

In side-deals, Southern Peru stockholders Cerro and Phelps Dodge, who wanted to monetize their holdings, agreed to support the deal if Southern Peru would register their shares.  While the Special Committee chose not to take part in the negotiations on this, Handelsman was very much involved.  Handelsman was also heavily involved with the Special Committee but decided not to participate in its final vote on the advice of Goldman Sachs’ counsel.

Because the deal was conditioned on a two-thirds vote of all stockholders, not a majority-of-the-minority vote, Grupo Mexico only needed the additional vote of either Cerra or Phelps Dodge.  While the Cerro agreement was conditioned on the approval of the underlying deal by the Special Committee the Phelps Dodge agreement was not, leaving the Special Committee without veto power.

By the time of the stockholder vote five months later Southern Peru had significantly exceeded the projections upon which Goldman’s fairness opinion had been based and its stock price had risen substantially.  The Court criticized the Special Committee for not seeking to renegotiate the deal or ask Goldman to update its analysis.

In a post-trial opinion the Court held that entire fairness was the appropriate standard of review and the transaction was not entirely fair to Southern Peru.  The Court then awarded damages in the amount of Southern Peru stock in excess of that which Grupo Mexico should have received.  The Court refused to award rescissory damages (which would have been larger given Southern Peru’s subsequent performance) because of plaintiff’s six-year delay in proceeding to trial.

Notable points other than those already mentioned:

  • Once again the opinion demonstrates the skill with which Chancery judicial personnel will evaluate economic arguments on valuation.
  • The Court held that, with respect to a controlling stockholder transaction, even a special committee with independent and disinterested members must show that it functioned well and the Court will examine its conclusion substantively.
  • The Court held a disclosure materially incomplete for not reporting the Special Committee’s counteroffer, which was materially higher than the eventual price and made after due diligence and a presentation by the financial advisor.
  • Even a lengthy special committee negotiating process, including well-credentialed members and financial and legal advisors, will not immunize a large controlling stockholder deal if it fundamentally does not make economic sense.
  • Interestingly, the Court noted derivative plaintiff’s failure to attend trial, although it rejected a motion to disqualify him as inadequate.
  • The Court noted its earlier dismissal of the Special Committee members themselves including Handelsman and reaffirmed its holding that neither bad faith nor self-dealing had been shown.  Nevertheless, it held that the interest of Handelsman in obtaining liquidity for Cerro had compromised his effectiveness on behalf of the Special Committee.
  • The Court criticized current Delaware law allowing an effective special committee process as to a controlling stockholder transaction to shift the burden of proof at most (as opposed to restoring business judgment rule).  The Court noted that while measures such as special committees are seen as beneficial to Delaware corporations and to be encouraged, burden shifting may not be much of an encouragement as it is almost never outcome-determinative because the Court is rarely in equipoise.
  • The Court again proposed that a combination of sufficient protective procedural devices (use of a special committee with negotiation, approval, and veto authority; and a fully informed majority-of-the-minority vote by stockholders) cause the business judgment rule to be restored.  But the Court also suggested that the Delaware Supreme Court would have to modify its precedent (e.g. the venerable Kahn v. Lynch) to do so.

Filed under: Controlling Stockholder, Court of Chancery, Derivative Actions, Fiduciary Duties

Chancery Validates Opt-In Method To Avoid Appraisal Remedy

The Court published a decision yesterday, Krieger v. Wesco Financial Corp. (available here), involving a matter of first impression under the Delaware appraisal statute.  The Court held that a judicial appraisal may not be available to stockholders even when receiving cash as a default matter if the stockholders are given an election to receive stock if they wish.  The short (10-page) decision bears reading by those who draft proxy statements and those who represent stockholders considering whether to assert appraisal rights.

Wesco underwent a merger with its parent Berkshire Hathaway, Inc. and a Berkshire subsidiary.  Under Delaware’s appraisal statute, Section 262, appraisal rights may be available in such mergers even when (as here) Wesco’s shares were listed on a national securities exchange.  Under Section 262 such rights are available if (to simplify a bit) the shareholders are “required” by the terms of the merger agreement to receive anything other than shares of stock in the surviving entity or a nationally traded company.  Wesco shareholders received cash as a default, but could elect to receive shares  in another Berkshire entity.

The Court ruled that under the language of 262 the shareholders were not “required” to accept cash and therefore an appraisal remedy was not available.  In doing so it rejected the argument that appraisal rights were available, on a stockholder-by-stockholder basis, to those stockholders who did not elect.

Wesco had informed stockholders that it believed appraisal rights were not available but that there were no authorities one way or the other.  The Court noted that this had been an accurate statement.

The Wesco proxy statement also stated that Wesco reserved the right to “take the position that appraisal . . . may not be exercised with respect to any shares as to which cash was elected or stock was received.”  The Court noted that such a position would have been incorrect as the appraisal statute does not depend on an individual stockholder’s election; and that a quasi-appraisal remedy could be available if such a disclosure was material.  The Court, however, held the statement to be immaterial here because appraisal was not available in any event.

Two points of interest here.  First, the Court did not make a distinction between Wesco stating that it might take such a position later as opposed to purporting to state the law. Thus, if a disclosure is otherwise innacurate, phrasing it as a potential position may not help avoid a quasi-appraisal remedy.

Second, the Court did not discuss any argument that the disclosure might have discouraged stockholders from electing to receive stock if they concluded (i) from the disclosures of the absence of specific decisional law on point that an appraisal remedy might be available and (ii) that not making an the election to receive stock (consideration the availability of which makes the appraisal remedy unavailable) gave them a better chance of receiving an appraisal.  The Court either did not hear this argument or, if it did, was not swayed by it.

Filed under: Appraisal, Court of Chancery

Chancery Dismisses Derivative Case Against Goldman

Today the Court issued a decision in derivative litigation regarding Goldman Sachs and its trading strategies and compensation leading up to mortgage and housing crisis of a few years ago.  Vice Chancellor Glasscock, recently appointed to the bench, issued the decision granting defendants’ motion to dismiss.

The decision reaffirms, from the newest member of the Court, the old principle that the Court of Chancery will not accept breach of fiduciary duty suits bottomed on questions of whether a particular business or compensation strategy was wise.

It also reaffirms the principle that donations by a company to a director’s charities do not in and of themselves prevent that director from being independent.

Filed under: Court of Chancery, Derivative Actions, Fiduciary Duties

Chancery Approves Retaining Liens for Lawyers

One previously unanswered question in Delaware, one I have seen come up before, is whether a lawyer may retain a client’s papers as security for payment of an overdue legal bill. In the U.S. such a procedure is recognized generally but countered by the equally well-recognized ethical obligations of attorneys to their former clients.  The clash of these principles has reached varying resolutions in different US jurisdictions. In a case of first impression, the Court of Chancery recently held that a lawyer may assert such a lien subject to a multi-factor balancing test governing whether and how to do so.

In Judy v. Preferred Communications Systems, Inc., available here, plaintiff fell behind on his legal bills to his original counsel to the tune of hundreds of thousands of dollars. Plaintiff ultimately retained new counsel then demanded the old firm forward his legal papers.

The Court quoted at length Informal ABA Committee Opinion No. 1461.  This Opinion  sets out several factors which have been used by other courts adjudicating this issue.  These factors included:

  • Financial situation of the client
  • Sophistication of the client in dealing with lawyers
  • Whether the client clearly understood and agreed to pay the amount now owing
  • Whether the retaining lien would prejudice important rights or interests of the client or other parties
  • Whether there are less stringent ways to resolve the matter
  • Whether there was agreement on amount or method of calculating a fee

Applying the factors to the case, the Court concluded that a retaining lien was appropriate, because among other reasons plaintiff was sophisticated, clearly understood and agreed to the fee owed, and did not assert it was in financial difficulty.

The Court indicated it would take into account the financial situation of counsel as well as client.

The Court noted that the client is commonly required to post security while client and counsel resolve their dispute, form and amount of security dependent on the circumstances (e.g. less if the client is impecunious).  The court approved counsel’s “responsible” request for 70% security, but indicated that it otherwise would have approved 100% or close to it.

The Court rejected a more stringent factor asking whether the lien was necessary to prevent fraud or gross imposition.  It reasoned that such a factor ignores the financial issues nonpayment of fees can present to the lawyer.  And it emphasized that it was deciding counsel’s legal ability to assert the lien and not whether doing so was ethical, citing the Delaware Supreme Court decision In re Infotechnology restraining parties in certain cases from using allegations of ethical violations in Delaware civil litigation.

Thus after Judy Delaware counsel now have a caselaw foundation for asserting retaining liens as well as guidance to understanding how courts will consider and handle this issue.

Filed under: Court of Chancery, Delaware Supreme Court

Brophy Claim Does Not Require Harm To Company

The Delaware Supreme Court recently reversed the Court of Chancery to rule that a claim for insider trading based upon Delaware state fiduciary duty law, a so-called “Brophy” claim after the leading (Court of Chancery) case in that line, does not require proof of harm to the company.  Rather, the defendant can be required to disgorge profits previously received even where the company arguably was not harmed monetarily.  The Court in doing so also reaffirmed the vitality of the Brophy claim alongside federal law also dealing with insider trading claims.

In Kahn v. KKR & Co., LP, plaintiffs made a claim against KKR under Brophy v. Cities Service Co. for trading on the stock of nominal defendant Primedia, Inc. while in possession of nonpublic information (Primedia’s earnings would be better than previously forecasted).  The Court of Chancery granted defendants’ motion to dismiss.  The Court reasoned, among other things, that a disgorgement remedy would not be available to plaintiffs because there was no direct harm to Primedia, distinguishing the case from Brophy.

In Brophy, the defendant had acquired inside information that the corporation was about to purchase its own shares.  The defendant then bought a large number of shares and resold them after the corporation’s purchases had caused the stock price to rise.  The Court of Chancery in Kahn characterized Brophy itself as a case in which an insider “used confidential corporate information to compete directly with the corporation.”  It held that disgorgement was also theoretically available in Brophy cases involving actual fraud.

As those whose memories still stretch back to their Corporations and/or Securities Law classes in law school will recall, one of the controversies originally surrounding the federal laws concerning insider trading is that some argued that such conduct should not be an addressed because it did not harm the corporation.  While that view did not generally prevail with respect to federal securities laws, the Court of Chancery’s holding would have significantly limited the Brophy cause of action and a remedy for insider trading under Delaware state law.

The Supreme Court en Banc reversed, calling the Chancery decision “thoughtful but unduly narrow.”  The Court noted that Brophy itself had stated broadly, “In equity, when the breach of confidential relation by an employee is relied on and an accounting for any resulting profit is sought, loss to the corporation need not be charged in the complaint . . . Public policy will not permit an employee occupying a position of trust and confidence toward his employer to abuse that relation to his own profit, regardless of whether his employer suffers a loss.”

The Court cited the well-known principle that “Delaware law dictates that the scope of recovery for a breach of the duty of loyalty is not to be determined narrowly.”  It also cited the venerable Guth v. Loft case for its statement that the rule that a fiduciary must return profits gained in breach of his or her duty does not rest upon narrow grounds of injury to the corporation “but upon a broader foundation of a wise public policy that, for the purpose of removing all temptation, extinguishes all possibility of profit flowing from a breach of the confidence imposed by the fiduciary relation.”

Filed under: Brophy (Insider Trading) Claim, Fiduciary Duties

Strine and Glasscock are Confirmed for Chancery

As previously noted in this blog, the Governor of Delaware had nominated sitting Vice Chancellor Leo E. Strine, Jr. to become Chancellor in the wake of the retirement of Chancellor William B. Chandler, III. Since Strine’s elevation to the position opened up another seat on the Court, the Governor nominated sitting Master Sam Glasscock, III as Vice Chancellor.

As expected, both were confirmed by the Delaware Senate, Strine on June 22 and Glasscock on June 29.

Filed under: Court of Chancery

Strine And Glasscock Nominated

The word is out — current Court of Chancery Vice Chancellor Leo E. Strine, Jr. and Master Sam Glasscock have been nominated by the Governor to be Chancellor and Vice Chancellor, respectively. Since the Delaware Senate’s term ends on June 30, votes on their confirmation will likely occur before then.

Filed under: Uncategorized

Pages

Disclaimer

Delaware Corporate Law Update solely reflect the views of Evan Williford of The Williford Firm, LLP. Its purpose is to provide general information concerning Delaware law; no representation is made about the accuracy of any information contained herein, and it may or may not be updated to reflect subsequent relevant events. This website is not intended to provide legal advice. It does not form any attorney-client relationship and it is not a substitute for one.
Follow

Get every new post delivered to your Inbox.