Delaware Corporate Law Update

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

New Chancery Judges Nominated

Governor John Carney announced on Thursday that he would nominate two individuals to be Vice Chancellors on the Delaware Court of Chancery: Morgan Zurn and Kathaleen McCormick.

This follows on the heels of successful legislation to expand the Delaware Court of Chancery by two additional jurists, moving the total number from five to seven.  That expansion was approved this summer.

Along with current Vice Chancellor Tamika Montgomery-Reeves, this would bring the total number of female Vice Chancellors to three of seven.  Before Montgomery-Reeves’ appointment in 2015, the first female Vice Chancellor, Carolyn Berger, served from 1984 to 1994.

Morgan Zurn has been serving as a Master in Chancery since 2016.  She previously worked as Deputy Attorney General for Delaware’s Department of Justice and at Morris, Nichols, Arsht & Tunnell LLP.

Kathaleen McCormick is a Partner at Young Conaway Stargatt & Taylor, LLP, where her focus is corporate, commercial, and alternative entity litigation in the Court of Chancery.



Filed under: Court of Chancery

Delaware Courts: New Five P.M. Deadline

The Delaware Supreme Court recently ordered a new 5:00 p.m. deadline for most Delaware state court filings to be considered timely filed that day.  The action follows on the heels of the District Court’s 6:00 p.m. filing deadline, adopted in 2014.  Wise Delaware and out-of-state counsel will carefully consider any necessary measures (such as moving work to the day before) this new deadline will require.

The order comes into effect September 14.  All filings in non-expedited cases before Delaware state courts – except initial pleadings and notices of appeal – must be made before 5:00 p.m. Eastern Time to be considered timely filed that day.

This change comes based on a report recommending this and several other changes to improve work/life balance for lawyers and their staff.  The report noted that this in particular was a “contested” change.  The report recognizes a criticism that the earlier deadline will simply result in more work on the previous day (or night).  However, the report argues that when late filings are “the result of the human tendency to delay until any deadline, especially on the part of those who do not bear the worst consequences of delay, what can result is a dispiriting and unnecessary requirement for litigators and support staff to routinely be in the office late at night to file papers that could have been filed during the business day.”  And in the case of expedited filings, where procrastination may be less of a factor, the deadline remains midnight.

The Supreme Court also ordered Delaware courts to consider other work/life balance policies discouraging (1) deadlines on Mondays or the day after a holiday, (2) court opinions deciding dispositive motions or post-trial relief after noon on Fridays or 4:00 p.m. any other day, and (3) scheduling oral arguments or trials in August.

Delaware and out-of-state counsel would do well to reflect on the changes in workflow that will be necessary to submit the same high-quality, often labor-intensive work product.  As Francis Pileggi notes in his blog, California counsel will need to complete any work on filings several hours before typical close of business there.  And if there is extra work the day before that is not certain to be completed the next day (whether that be from procrastination, miscommunication, or simply the human condition), any overtime/nighttime work will have to be done the night before.

Filed under: Court of Chancery, Delaware Supreme Court, Expedited

Goggin: LLC Fudges Fiduciary Duties

In MHS Capital LLC v. Goggin, the Court of Chancery had to interpret an oddly-drafted LLC agreement provision regarding fiduciary duties.  Goggin shows why it is in the interests of both LLC management and investors to have knowledgeable lawyers carefully review such documents.  It also shows a Delaware court dealing with the difficult task of interpreting such a provision and coming to a result that is equitable but also consistent with its plain language.

The lawsuit arose from a transaction in which the LLC’s manager allegedly diverted assets in a bankruptcy proceeding from the LLC to a group of entities of which the LLC was only one.  Plaintiff filed suit; the individual defendants moved to dismiss the complaint.

The LLC’s operating agreement contained two interesting provisions relating to fiduciary duties.  First, the agreement required the manager to act “with the care an ordinarily prudent person in a like position would exercise under similar circumstances” (as well as “in good faith” and “in a manner [he] reasonably believes to be in the best interests of the Company”).  As Delaware corporate litigation practitioners know, the default Delaware entity duty of care typically only requires behavior that is not grossly negligent, it does not impose the much higher standard of ordinary care.

Second, the agreement provided that the manager was not “liable . . . for monetary damages” for breach of his or her “duty as a Manager, except as otherwise required under the [Delaware LLC] Act.”  It is not uncommon to see waivers of damages for violating the duty of care (“Section 102(b)(7) provisions”), but those typically exclude other duties (such as good faith).

Defendants did not argue that the alleged conduct was not a breach of the fiduciary duties set forth in the agreement.  Rather, defendants argued that plaintiff’s case should be dismissed because the waiver of damages precluded a remedy.  The Court, however, emphasized that plaintiff was seeking to “disgorge the monetary proceeds received” from the alleged misconduct and “impose a constructive trust”.  The Court ruled that if a claim is stated, “the nature of [] relief [for that claim] is not relevant and need not be addressed.”  As such, the Court “need not decide whether [plaintiff’s] request for some forms of equitable relief is so close to a request for monetary damages that it runs afoul of the exculpatory provision.”  In so ruling, the Court stated that “the way the operating agreement’s ‘Manager’ standard of care—good faith and ordinary care—is meant to work with the exculpatory clause, which purports to eliminate all damages, is unclear to me.”

Faced with a non-standard fiduciary duty provision, the Court ruled that – in this case and at this stage of the litigation – the provision did not preclude plaintiff’s claims.  Thus, in a way the provision ended up costing both sides: defendants by not eliminating costly discovery and further proceedings on plaintiff’s claims; plaintiffs by preserving a chance that after such costly further proceedings the Court might hold that the appropriate remedy is unavailable after all.

The Goggin case shows the importance of having knowledgeable lawyers draft or review fiduciary duty provisions in LLC agreements before they are finalized.  Delaware fiduciary duties have many wrinkles that even an intelligent layperson, or a lawyer not familiar with the subject matter, might miss.  Costly litigation or uncertainty may be the price for not reviewing such provisions carefully.

Filed under: Court of Chancery, Fiduciary Duties

What’s the Big Deal with Blockchain?

Over the past year or so there has been a good deal of discussion about using “blockchain” technology as a method to store corporate records, particularly about stockholders.  But what exactly is blockchain anyway, and is it coming soon to a Delaware corporation near you?

What is “blockchain”?  Blockchain technology was invented by the unidentified founder (alias “Satoshi Nakamoto”) of, and used in the establishment of, the currency “bitcoin”.  For those who have been living under a rock for the past ten years, bitcoin is a type of money that operates without a central authority and, as of January 11, 2018, had a market capitalization of approximately $240 billion.

Blockchain technology operates by replacing a single record-book with multiple identical record-books maintained by a network of participants.  For instance, with respect to bitcoin, it has enabled the creation of an entirely electronic currency (no actual coins or counterfeit-proof paper bills needed) without the necessity for a central authority to keep records of it (which central authority would need to be trusted and possibly paid by transaction fees).

There are several ways that technology has, both generally and with respect to bitcoin, to reduce the possibility of fraud.  For instance, it can apply decision rules to resolve disputes, such as when copies of the record-book disagree with others as to a transaction.

So what is the connection to Delaware corporate law?  One way in which blockchain technology shows promise is as a replacement for record-books of corporate stockholders.  As corporate lawyers know, but John Q. Stockholder might be surprised to learn, “stockholders” of large publicly held Delaware corporations frequently don’t hold their own shares.

Rather, they are what the law calls “beneficial owners”.  For historical reasons, the system that has evolved in the Unites States is that most such shares of stock are held by an organization called Depository Trust Company (“DTC”) and issued in the name of its nominee, Cede & Company (“Cede”).

So, if a “beneficial owner” wishes to vote their shares, they frequently must tell their broker to tell Cede to vote the way they want or use some other equivalent process.  This can give rise to costly unfair results.  For instance, in one phase of the Dell appraisal litigation, because the name of the stockholder of record changed, Delaware law requiring continuous ownership of shares was violated, resulting in a lost potential damages award.  In another, a mistaken instruction cost a stockholder a potential $200 million award.

One of the long-term promises of blockchain technology is to replace DTC, thereby reunifying beneficial and record ownership and hopefully eliminating some potentially unfair results under Delaware law.  A recently published article by Vice Chancellor J. Travis Laster and Skadden Arps lawyer Marcel Rosner, Distributed Stock Ledgers and Delaware Law, 73 Bus. Law. 319 (Spring 2018), goes into detail regarding blockchain technology and the promise it holds for various facets of Delaware law, and is recommended reading for those looking for a deeper understanding.

Is blockchain technology coming to a Delaware corporation near me?  The answer is maybe, but slowly.  The Delaware General Corporation Law was amended in 2017 to permit, theoretically and under certain conditions, keeping corporate records like stock ownership in blockchain format.  That being said, law and corporate America can be conservative.  The path is open for enterprising Delaware corporations to use and show the success of blockchain recordkeeping, and perhaps others will follow.

In the meantime, as Vice Chancellor Laster recommended in the first Dell decision discussed above, Delaware courts (or the Delaware legislature, for that matter), could consider changing Delaware law to ameliorate these argued unfair results.

Filed under: Appraisal, Court of Chancery

Back from the Dead: Inadequate Reserve Revives LLC

In a recent decision, Capone v. LDH Management Holdings LLC, the Delaware Court of Chancery nullified the certificate of cancellation of a Delaware LLC.  The Court did so because the LLC had established no reserve for legal claims previously known to it.  The decision highlights the requirement under Delaware law that, before an LLC is cancelled, it must make reasonable provision for known nonfrivolous claims:  zero is not enough.  If a reasonable reserve is not made, the entity may (as happened here) later be revived.

Plaintiffs were holders of units in a Delaware LLC (“Management Holdings”), which in turn was valued based on its holdings of units in another LLC (“LDH”).  Under the former LLC’s agreement, Management Holdings had the right to (and did) redeem plaintiffs’ units at a price set by a specified process.  Plaintiffs claimed that the valuation of LDH by which their units were valued was too low by some half a billion dollars, and they voiced those claims (vociferously in some cases) to management.

Nevertheless, Management Holdings’ certificate of formation was cancelled, with no reserve having been established for such claims.  Plaintiffs sued in New York on their claim that the valuation had been improper and thus a breach of contract.  When they discovered that Management Holdings had been cancelled, they filed a lawsuit in Delaware to nullify the certificate of cancellation.

On cross-motions for summary judgment, the Court granted judgment for plaintiffs.  After reviewing the applicable sections of the Delaware LLC Act and the nature of plaintiffs’ claims, the Court ruled that defendants were in fact aware of the claims due to plaintiffs’ complaints.

Next the Court discussed the establishment of a reasonable reserve under 6 Del. C. § 18-804.  In the Court’s view, that would involve factors including the potential amount of the claim as well as the likelihood of it becoming a liability.  The Court noted that a claim could in fact be “so obviously frivolous that a reserve of zero dollars would likely be sufficient”.  That being said, it concluded that plaintiffs’ reading of the LLC agreement was a “reasonable construction” and not “indisputably wrong,” and therefore a reserve of $0 was a violation of the Delaware LLC Act.  Accordingly, the Court nullified the LLC’s certificate of cancellation, thereby reviving the entity.

Key takeaways from the Court’s decision:

  • Establishing a $0 reserve for a nonfrivolous claim for a substantial amount of money may well result in an LLC’s certificate of cancellation being nullified.
  • Managers of an LLC must make reasonable provision for any known potential claims before filing a certificate of cancellation. In doing so, they may consider the likelihood that the claim will be successful, along with the potential liability if successful.
  • “[E]ven a relatively weak claim may justify a reserve,” particularly when the potential damages are large.

Filed under: Court of Chancery, LLC

Delaware Chancery Orders Defendant Directors Deposed on SLC’s Motion to Terminate Claims

Courts are restrictive in granting a plaintiff discovery in connection with the motion of a special litigation committee (an “SLC”) to terminate claims.  That is particularly true with regard to discovery directed toward defendant directors.  In a recent transcript decision, Judy v. Agar, the Court of Chancery denied motions of two defendant directors for protective orders against their depositions and certain document discovery.  The Court cited the lengthy past litigation history of the company (characterizing it as having a “black halo”), but also discussed the kinds of allegations that in its view justified such depositions.  This decision is useful because there is little caselaw discussing the scope of discovery in this context other than from an SLC.

In this case, plaintiffs sought and received discovery from the SLC.  The key question on defendants’ motions was what discovery plaintiffs would be permitted from certain defendant directors who benefited from the SLC’s motion to dismiss certain claims.

The Court denied the motions and began with the observation that this was not “a typical case”.  Rather, it continued, the case was one “that I’ve had for however many years now where people hide things, they lie, they engage in fraud.”  “No phase of this company’s multi-phase history has ever involved actions that are inspiring of confidence,” said the Court.  But for that background, the Court said it would have been “highly likely” to “limit the scope” of discovery.

The Court also observed that other circumstances “were probably sufficient to warrant a deposition regardless”.  One director had engaged in communications with the (single-member) SLC concerning its functioning such as whether an in-person meeting with plaintiffs’ counsel was appropriate, fees the SLC should pay, and changes in SLC composition upon the election of new directors.  The Court held that those communications “are probably sufficient to warrant a deposition regardless.”  Similarly, it held that another director’s relationships with certain parties, particularly the SLC, were sufficient to warrant his deposition.

Separately, the Court noted that no live testimony would be permitted in the hearing on the SLC’s motion to terminate certain claims (a “Zapata” hearing), reasoning that the applicable standard was akin to a summary judgment motion.

The Court did not lay down a new rule or standard for discovery from defendant directors as to an SLC’s motion to terminate litigation.  It is a given that such discovery may be difficult to obtain and may require a particularized showing from plaintiff.  The Court, however, may be influenced by extensive past bad conduct on the part of the company or those associated with it.   It may also grant discovery into (1) communications between the SLC and the defendant director about the functioning of the SLC; and (2) specific relationships between the defendant director and others, particularly the SLC, that could have a bearing on the SLC’s motion.

The Williford Firm LLC serves as counsel for plaintiffs in this action.

Filed under: Court of Chancery, Derivative Actions, Zapata

No Standing For Stockholder Squeezed Out Before Books and Records Suit

On February 27, the Court of Chancery in Weingarten v. Monster Worldwide, Inc. held as a matter of first impression that a stockholder cashed out in a merger lacked standing when he served a books and records demand under 8 Del. C. § 220, but did not sue, before the merger closed.

The Court sidestepped policy arguments by applying the “unambiguous language” of the statute, which requires a stockholder to “first establish” that “[s]uch stockholder is a stockholder”.  The Court held that the statute thus “made clear that only those who are stockholders at the time of filing have standing to invoke this Court’s assistance under Section 220.”

The Court distinguished two other Court of Chancery cases where plaintiffs had been squeezed out after – not before – filing their Section 220 complaints.

For lawyers representing aggrieved holders of stock in a company soon to merge, the lesson of Weingarten is clear.  Serve the demand and file suit before the merger closes – or risk dismissal for lack of standing.

Filed under: Court of Chancery, Section 220 Books and Records, Standing

Chancery Court Denies “Litigation Financier” Attorneys’ Fees

In Judy v. Preferred Communication Systems, Inc., (opinion available here), decided September 20, the Court rejected a motion by intervenor Preferred Spectrum Investments, LLC (“PSI”) for attorneys’ fees.  Judy rules that litigation financiers do not have standing to seek attorneys’ fees for corporate benefits created by the funded lawsuit.  It is also a useful review of many of the reasons a fee petition might be rejected.

Preferred Communication Systems, Inc. (“PCSI”) was formed by individuals with criminal records, including Pendleton Waugh, to buy licenses issued by the Federal Communications Commission (the “FCC”) and solicit money from investors.  Later Waugh was ousted from control of PCS; then he along with new ally Carole Downs formed PSI as a vehicle to regain control of PCSI and to solicit additional investor funds.  They told investors they would use those funds to loan money to PCSI in return for equity.  When PCSI refused to agree to this, Downs and Waugh instead used PSI money to fund another associate, Michael Judy, to litigate a series of lawsuits in the Delaware Court of Chancery (as consolidated, the “Judy Action”).  Ultimately the Court in the Judy Action temporarily appointed a court receiver, made changes to PCSI’s capitalization, and ordered an annual meeting.

At a January 2013 annual meeting, a PSI-backed slate of directors including Downs and Judy (Waugh having passed away) was elected.  In June 2014, a transaction closed in which (in essence) PCSI sold many of its licenses to Sprint for $60M.  Later Judy and Downs had a falling out and persons closely associated with PSI including Downs were removed as PCSI directors.

PSI then intervened in the Judy Action to seek attorneys’ fees, albeit without the cooperation of plaintiff and former ally Judy.  PSI claimed that the Judy Action had saved PCSI and its licenses, sold and unsold.  It claimed tens of millions of dollars as its appropriate share of the value of those licenses under a corporate or common benefit theory.  Alternatively, PSI sought recovery of over $8M in alleged charges associated with the Judy Action under a quantum meruit theory.

The Preferred Investors Association (the “PIA”), an association of PCSI stockholders, took the lead in opposing the petition.  The Court wholly rejected the petition.

PSI lacked standing because it was not plaintiff, only “a source of financing”.  The Court followed past precedent which has refused to broaden the common benefit doctrine into a “generalized mechanism for achieving redistributive justice.”  The Court noted that PSI could have formed a contract with Judy to be repaid by a court-ordered fee award but chose not to.  Therefore, the Court rejected PSI’s argument: “Litigation financiers do not need the common benefit doctrine to give them an incentive to finance litigation.”

The Court also rejected the petition on the basis of precedent that the Court will not award fees if the litigation was filed in support of a takeover effort.

The Court also rejected PSI’s request for a percentage award upon concluding that PSI did not cause the benefit.  Even under PSI’s version of events, the Judy Action was only one of many reasons the licenses were monetized.  This led the Court to liken PSI’s argument to the story about the “horseshoe nail that lost the kingdom”.  In fact, the Court found, PSI had affirmatively jeopardized the licenses.

Finally, the Court separately rejected PSI’s quantum meruit theory for a number of reasons.  PSI had made previous representations to PCSI stockholders that they would not bear expenses associated with the Judy Action.  The Court also found a host of factual issues with the various claimed costs (for example, some were not associated with the litigation, while others paid for arguments not in PCSI’s interests).

The Williford Firm LLC served as counsel for the PIA in this action.

Filed under: Attorneys' Fees, Court of Chancery

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




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.