Delaware Corporate Law Update

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

Good Things (Sometimes) Come To Those Who Wait: Two Recent Cases Show Pros And Cons To Seeking Books and Records Before Suing

When considering stockholder litigation in Chancery, one of the decisions plaintiffs face is whether to (1) sue immediately or (2) seek books and records under 8 Del. C. § 220 hoping for documents to help survive a motion to dismiss.  This summer, two cases where plaintiffs took the latter route had very different outcomes.

In August, the Court in In re Investors Bancorp, Inc. Stockholder Litigation considered cross motions to appoint lead plaintiffs in a case attacking director compensation as self-interested.  One plaintiff served a books and records request, obtained documents, and filed a complaint twice as long as the other.  While the Court complimented all counsel as “highly competent,” it placed decisive weight on the significant additional information the former uncovered.  For instance, in arguing that the compensation was a self-interested quid pro quo scheme, the latter solely used temporal proximity while the former cited board minutes.  The Court found that the information added by the former counsel was “not fluff;” rather, the former used documents “including board and compensation committee meeting minutes, to provide meaningful, additional factual support for their allegations.”

In June, however, the Court held a complaint filed after litigating a Section 220 action was precluded by the dismissal of another similar complaint two years earlier (Bensoussan).  The Court responded to plaintiff’s argument that the original plaintiff was an inadequate representative by ruling it was reluctant to judge “inadequacy based on the contents of documents obtained in response to a Section 220 demand because that approach ‘encourages hindsight review of conduct’”.  (A plaintiff in such a situation may also contend, whether or not based upon additional books and records, that the claims in the later suit are substantively different from the ones in the prior suit.)  The Court cited two other Delaware cases with similar outcomes.

Thus, as one of the “tools at hand” a books and records demand is a double-edged sword: it may lead to a superior complaint or a precluded one.  In determining whether to make such a demand plaintiffs’ counsel should carefully consider and monitor, among other things: (1) the likelihood of other similar complaints being filed; (2) the likelihood of uncovering evidence that could make the difference on a motion to dismiss (a surviving plaintiff can of course seek merits discovery); and (3) the speed with which the demand will procure helpful documents.  (As the Court in Investors Bancorp noted, a plaintiff faced with a slow demand response can always decide to abandon it and file a merits suit anyway.)

Filed under: Court of Chancery, Derivative Actions, Preclusion, Section 220 Books and Records

Xoom: Chancery Awards Fee For Modest Disclosures Without Release

On August 4, in In re Xoom Corp. Stockholder Litigation, Vice Chancellor Glasscock signaled a limitation on the Court of Chancery’s recent caselaw critical of attorneys’ fee awards for additional merger disclosures.  The Court awarded $50,000 even though it held that the disclosures had only modest value because there was no release; plaintiffs’ claims had therefore been mooted, not settled.

A little background: in September 2015, Vice Chancellor Glasscock approved a merger settlement awarding fees which exchanged supplemental disclosures for a broad release of claims, but he criticized such settlements and warned against future Court approval (Riverbed).  In January 2016, Chancellor Bouchard rejected a disclosure-only settlement that did not address a “plainly material misrepresentation or omission” (Trulia); in August, Judge Richard Posner of the U.S. Court of Appeals for the Seventh Circuit did the same (Walgreens).

In Xoom, plaintiffs sought fees for supplemental disclosures made in connection with the merger of Xoom Corporation into PayPal Holdings, Inc.  The Court ruled, however, that the mootness context supported a different analysis than recent prior cases.  This case, to the contrary, did not involve a broad release of claims.  Thus, plaintiffs had provided a benefit to the class without giving anything up.  While the disclosures worked only a modest benefit, the Court nonetheless awarded some of the fees requested “to encourage wholesome levels of litigation.”

Filed under: Attorneys' Fees, Court of Chancery

Chancery Court Dismisses Caremark Claim

In Melbourne Municipal Firefighters’ Pension Trust Fund v. Jacobs (opinion available here), Vice Chancellor Montgomery-Reeves dismissed a fiduciary duty claim for failure of oversight (a so-called “Caremark claim”).  Caremark claims are well-known for being difficult to succeed on, and Melbourne further defines the limited circumstances where one is colorable.

Qualcomm, Inc. has paid more than one billion dollars for antitrust violations, including:  1) a $891M settlement for a 2005 claim by competitor Broadcom; 2) a $208M fine in 2009 by South Korea; 3) a 2010 claim by Japan still pending; and 4) a $975M fine in 2015 by China.  While these cases involved different allegations of wrongdoing, many involved Qualcomm’s market dominance in certain products used in wireless communications coupled with the same alleged failure to license its products on fair, reasonable and non-discriminatory (“FRAND”) terms.  Plaintiff alleged the first three cases were red flags that should have prompted Qualcomm’s board of directors to prevent the fourth.

Plaintiff filed its complaint after succeeding via a books-and-records case at getting some 14,000 pages of documents including board materials.  Plaintiff’s complaint pointed to board materials showing that Qualcomm’s board knew it expected to continue to face regulatory complaints and investigations in the future.   Rather than modifying its policies or prices to reduce or eliminate risk, however, Qualcomm’s board’s strategy on this issue was to educate “industry participants and government officials as to why its practices were legal” and to “pursu[e] appeals.”  Under Delaware law, “a fiduciary may not choose to manage an entity in an illegal fashion, even if the fiduciary believes that the illegal activity will result in profits for the entity.”

The Court held that plaintiffs did not state a claim.  In doing so it compared plaintiff’s claims to two cases in which Caremark claims survived.

In Massey Energy Co., a coal mining company had failed to change safety practices that later lead to the company pleading guilty to criminal charges including one count for violating safety standards resulting in death and a $4.5M fine.  The Court noted that in Massey the company’s CEO “publicly stated that the idea that governmental safety regulators knew more about mine safety than he did was silly.”  The Court distinguished Massey on the grounds that the red flags alleged there were far more egregious and indisputable; and that in that case the company had challenged the law itself, whereas in this case Qualcomm had not contested the antitrust laws themselves but taken the position that its conduct did not violate them.

In Pyott, the Board and CEO of a drug company knowingly approved a business plan that violated a ban on marketing drugs for off-label use.  It did so despite general counsel’s advice that the company “likely had engaged in such illegal conduct”.  Pyott criticized the Board’s view of the distinction between off-label selling and marketing “as a source of legal risk to be managed, rather than a boundary to be avoided.”  The Court emphasized that Pyott was based on the board’s alleged decision to cause the company to engage in illegal conduct, whereas here the allegation was that Qualcomm’s board did not put a halt to it.  Moreover, again, Qualcomm’s board had taken the position that its conduct did not violate the relevant rules.

Caremark claims are difficult in part because they strain against the boundaries of a basic principle of Delaware law, the business judgment rule.  As the Court observed in a quotation taken from another case, “In any business decision that turns out poorly there will likely be signs that one could point to and argue are evidence that the decision was wrong. . . . This temptation, however, is one of the reasons for the presumption against an objective review of business decisions by judges, a presumption that is no less applicable when the losses to the Company are large.”

Melbourne reinforces the view that Caremark claims are difficult to prevail on and that even decisions on whether one is colorable may well be fact-specific.  Other lessons of Melbourne are as follows:

  • Board or management statements of their well-informed belief that the activities in question are legal are helpful in defending such a claim.
  • On the other hand, statements that express or imply knowledge that such activities are illegal or show disrespect for regulatory authorities are unhelpful.
  • Legal rules protecting employee or customer well-being or safety, or those that involve or result in criminal prosecution, may be more dangerous to transgress than economic rules such as antitrust.
  • Creating a policy is more vulnerable than failing to discontinue an already-created one.
  • Board documents reaffirming the legality of a particular policy, and addressing and creating a strategy for continuing to support it, may support a later defense of failure to eliminate the policy. That being said, plaintiffs may also point to such documents as proof of red flags.

Filed under: Caremark, Court of Chancery

2016 DGCL Amendments

On August 1, 2016, the latest amendments to the Delaware General Corporation Law became effective (amendments available here).

Two sets of amendments are summarized below.  One set limits the availability and extent of the appraisal remedy, while another expands the Court of Chancery’s jurisdiction over disputes involving certain corporation stock or asset sale agreements.

Appraisal amendments – One amendment prohibits certain appraisals of shares of public corporations.  It has three exceptions:

  • It does not apply to short-form mergers (i.e. the parent owned at least 90% of the subsidiary’s shares before the merger).
  • It does not apply if the shares entitled to appraisal (their holders have perfected their appraisal rights) exceed 1% of those eligible.
  • It does not apply if the merger consideration for the shares entitled to appraisal is greater than $1M.

Another amendment allows corporations to avoid paying interest on appraisal awards if and to the extent they prepay the amount to those entitled to appraisal.  This amendment was adopted due to a concern that some appraisal proceedings were at least partly motivated by the difference between low current interest rates and the high legal interest rate available in appraisal actions.

Chancery jurisdictional amendment – Section 111 has been amended to expand the Court of Chancery’s subject-matter jurisdiction.  The Court may now hear cases involving agreements between a corporation and one or more stockholders in which stockholders sell or offer to sell their stock.  It also has nonexclusive jurisdiction over cases involving agreements by corporations to sell, lease or exchange assets pursuant to stockholder consent.  This amendment expands the Court of Chancery’s jurisdiction to contractual disputes typically involving many of the same issues the Court of Chancery already dealt with in its preexisting jurisdiction.

Sandra Feldman of CT Corporation summarizes other 2016 amendments to Delaware’s various business entity laws here.

Filed under: Appraisal, Court of Chancery, Subject-matter jurisdiction

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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.