Delaware Corporate Law Update

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

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

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

Further Update on Appointment of New Chancellor

It has been reported by the Delaware Grapevine (here) that the three names forwarded by the Judicial Nominating Committee to the Governor with respect to the next Chancellor of the Delaware Court of Chancery are: Karen L. Valihura, Esquire, a partner practicing corporate litigation at Skadden Arps; Leo E. Strine Jr., a Vice Chancellor of the Court of Chancery; and Sam Glasscock III, a Master of the Court of Chancery.  The Governor would most likely pick one of the three candidates recommended to him by the committee, and the pick would then be forwarded to the state Senate for confirmation proceedings.

Filed under: Court of Chancery

Chancery Rules on Revlon Standard For Mixed Cash/Stock Deals

On May 20, the Court ruled in In re Smurfit-Stone Container Corp. Shareholder Litigation  that a merger transaction with consideration of 50% cash and 50% stock was subject to heightened “Revlon” scrutiny.  In two previous cases, the Delaware Supreme Court had ruled that a 33% cash deal was not, while the Court of Chancery had assumed without deciding that a 62% cash deal was.  Smurfit-Stone provides more guidance from the Court on the circumstances in which heightened “Revlon” scrutiny will apply in mixed cash/stock deals, assuming the target does not have a controlling stockholder or stockholder group.  Such scrutiny will apply where either (i) a stockholder or stockholder group will control the combined entity; or (ii) some large portion of the consideration is cash.  As to how much cash will trigger heightened scrutiny, Smurfit-Stone asks whether a “substantial” part of the stockholders’ investment has been cashed out, implying that Revlon may apply even where the percentage of cash is below 50%.

In Smurfit-Stone (opinion available here), plaintiffs moved for a preliminary injunction to block a merger between target Smurfit-Stone Container Corp. and a subsidiary of acquiror Rock-Tenn Company.  A board with a majority of outside directors approved the transaction after negotiations with Rock-Tenn and one another potential acquiror, but without a market-check.  Smurfit-Stone shareholders were to receive, for each share, $17.50 in cash and a percentage of a share of Rock-Tenn common stock worth approximately $17.50 at its closing price immediately prior to the announcement of the deal.

Vice Chancellor Donald F. Parsons, Jr. first determined whether Revlon applied.  Revlon has been held to apply, among other circumstances, when the transaction effects a “sale or change of control”.  Plaintiffs claimed that the merger would cause a sale or change of control.

The Court noted that all-cash deals have been held to constitute changes of control because there is “no tomorrow” for the stockholders: they are forever shut out of future corporate profits or the possibility of obtaining a control (or increased control) premium.  All-stock deals do not — unless the combined entity has a controlling stockholder or stockholder group in which case, again, the stockholders have lost the ability to obtain a control premium in future transactions.

The Court then discussed two Delaware cases concerning mixed cash/stock deals.  In In re Santa Fe Pacific Corp., 669 A.2d 59 (Del. 1995), the Delaware Supreme Court ruled Revlon inapplicable to a deal with 33% cash consideration (plaintiff had also not shown that the combined entity would have a controlling stockholder).  In In re Lukens, 757 A.2d 732 (Del. Ch. 1999), the Court of Chancery had ruled Revlon did apply to a deal in which each stockholder had the right to elect to receive consideration in cash, up to a maximum of 62% of the total deal, even though (again) the combined entity would have no controlling stockholder.

The Court held that its reasoning in Lukens applied to this case as well. Defendants had argued that Lukens did not apply because a majority of stockholders could conceivably have elected to cash out entirely in Lukens, but not here.  The Court disagreed:  “while no Smurfit-Stone stockholder will be cashed out 100%, 100% of its stockholders who elect to participate in the merger will see approximately 50% of their Smurfit-Stone investment cashed out.”  The Court characterized the “reasoning of Lukens” as concerning the Court’s need “to scrutinize under Revlon a transaction that constitutes an end-game for all or a substantial part of a stockholder’s investment in a Delaware corporation.” (emphasis added).

While the Court applied Revlon scrutiny, it went on to hold that the actions of the Smurfit-Stone board withstood this heightened scrutiny and, thus, denied plaintiffs’ motion for a preliminary injunction.

Smurfit-Stone reaffirms the result in Lukens that, in a mixed cash-stock consideration merger, Revlon may apply even if control of the resulting entity remains in the hands of public stockholders.  It also extends the holding in Lukens that 63% cash consideration will trigger Revlon to 50%, under the reasoning that Revlon governs any transaction in which “a substantial part” of stockholders’ investments are cashed out.

Furthermore, Smurfit-Stone suggests that Revlon may apply at cash consideration levels even below 50% — such consideration is certainly “substantial” under the plain meaning of the word.  Moreover, the Revlon analysis itself asks whether there has been a “change of control”.  Under Delaware law, a stockholder can be deemed “controlling” so as to incur fiduciary duties to the other stockholders even where its percentage stock-holding is below 50% (where actual control by the stockholder can be established factually).  Delaware courts have interpreted Revlon to be substantively less stringent over the years and more flexible to a good faith process implemented by an active board of directors, suggesting that they may, to a certain degree, be more willing to extend the doctrine.  (Indeed, it has been reported that in January 0f this year Vice Chancellor J. Travis Laster suggested that Revlon should apply in any end-stage transaction involving the last opportunity to negotiate a premium, including when that premium is paid in stock of the combined entity).

Notably, the actions giving rise to the case were filed in both Delaware and Illinois.  On the suggestion of defendants the Delaware and Illinois courts conferred, resulting in the Illinois court’s decision to stay the actions before it pending resolution of the Delaware action.  Such interactions between Delaware judges and judges in other jurisdictions seem to be becoming more common, particularly given recent disputes in Delaware courts about multidistrict litigation.  Such communication seems generally beneficial in eliminating duplicative work and expense for the courts and parties, as well as conflicts between the Delaware judicial system and that of other states.

Filed under: Court of Chancery, Preliminary Injunction, Revlon

“Close Calls” on Disclosing Management Projections And Expressions of Interest

On May 10, the Court of Chancery denied an expedited application to preliminarily enjoin a cash tender offer by a subsidiary of Laboratory Corporation of America Holdings, Inc. (“LabCorp”) for all stock in Orchid Cellmark Inc.  An interlocutory appeal to the Delaware Supreme Court followed but was refused.

Plaintiffs argued that the Orchid board should have disclosed to stockholders: (1) management’s projections which were more optimistic than the financial advisor’s (disclosed) “base case” projections; and (2) more information regarding expressions of interest by other parties.  The Court characterized these two arguments as “close calls” but ultimately rejected them for factual reasons.

Key Facts

Orchid CEO Thomas Bologna was the only insider on its six-member board.  After an indication of interest from LabCorp, ultimately for $2.80 per share, the board appointed a special committee and hired Oppenheimer & Co. as financial advisor.  Oppenheimer solicited six other potential buyers.

Several expressed interest only in Orchid’s UK business, for seven to eight times UK EBITDA.  According to Oppenheimer, when combined with Orchid’s substantial cash on hand this equaled $2.74 to $3.04 per share, or approximately $2.93.  Oppenheimer advised the board that it believed Orchid “could get a higher price from a U.K. buyer than the [LabCorp bid but] there would be attendant transactional execution risk.”

Oppenheimer’s internal financial analysis provided to the board included projections by the CFO in connection with a proposed deal with LabCorp and endorsed by Bologna, who opposed the transaction.  (At the proposed price at least some of Bologna’s Orchid options were underwater).  These projections were included originally as the “management” case, later (pas Oppenheimer came to regard them as optimistic)  as the “upside” case alongside “base” and “downside” cases.

The board deliberated about a sale of the UK operations and ultimately determined that the risks and uncertainties of pursuing a UK transaction did not maximize shareholder value.  The board, other than Bologna, ultimately voted to recommend the LabCorp offer to stockholders.

Orchid’s Recommendation Statement to stockholders disclosed that such a transaction was considered, but that Oppenheimer had advised the board that it presented certain risks, including financing availability, that made it unattractive.  It reported that Oppenheimer had stated to the board that “no third party would likely propose a bid for the company that would yield a result for the stockholders” higher than the LabCorp indication of interest.”  The Recommendation Statement disclosed Oppenheimer’s “base case,” but not management’s, projections.

The Court’s Rulings

Plaintiffs argued that the alternative of selling only the UK operations were inadequately disclosed.  The Recommendation Statement disclosed that the board considered such a transaction but not that Orchid received expressions of interest, nor that they were in a range which on average exceeded the tender offer price.  The Court determined that the omitted facts were not material, reasoning among other things that the offer price fell within the range of prices for the expressions of interest.  But the question was a “very close one.”

Plaintiffs also argued that the management projections should have been disclosed.  The Court distinguished the general rule that management cash flow estimates are material for disclosure purposes, noting that the management projections had been prepared and submitted in response to the transaction (one Bologna opposed) and finding that his underwater options gave him an incentive to argue that Orchid was worth more.  Again the issue was a “close one.”

Lessons from Orchid

Orchid reaffirms the ability of the Delaware Court of Chancery and Supreme Court to render decisions in a short time when necessary, including by detailed, fact-specific opinions when appropriate.  The tender offer expired on May 17.  The 37-page Orchid opinion was released on May 12, after a hearing earlier that same day.  An interlocutory appeal was submitted the day afterwards, a Friday, May 13; a three-justice panel of the Delaware Supreme Court reviewed and decided the application on Monday, May 16.

Orchid shows that even in the disclosure setting courts may give more deference to boards that are independent and engaged.  This was not a conflicted transaction, and it is apparent that the board and the special committee devoted a lot of time and energy to the process leading up to the transactions. The board further demonstrated independence by disagreeing with and outvoting the CEO.  These facts seemed to have significantly influenced the Court:  “In sum, this is an informed board, guided by competent legal and financial advisors.  It is independent and disinterested.  Its actions have been reasonable.  Perhaps there was a better path, but that seems unlikely.”

Certain facts, including regarding the UK expressions of interest, did not seem fully developed, although it is unclear whether that is because they were not brought out by the parties, not included in the opinion due to the expedited timeframe, or for some other reason.  Orchid reminds that if a plaintiff does not fully bring out the facts of a transaction that allegedly make it wrongful the defendant is likely to prevail.

It is unclear exactly why a UK transaction was not pursued.  Notwithstanding Orchid, it is risky for a board or special committee not to adequately explore an indication of interest or offer/bid — and if it does not it should be prepared to justify its decision in litigation.  In transactions such as this one where control of an entity is being sold, the heightened “Revlon” standard (not the business judgment rule) applies, making good faith exploration or consideration of all reasonably available alternatives even more of a focus.

Disclosures (or lack thereof) regarding projections and alternative bidders are typically significant and will be closely inspected.  As the Court noted, both issues were “close calls;” another court could conceivably have ruled differently, particularly upon a more complete record.  Since management projections are often prepared pending a proposed deal, that fact may not be determinative in the future, as noted in this lengthy, insightful summary of Orchid by Tom Bayliss of Abrams & Bayliss.

Filed under: Court of Chancery, Preliminary Injunction

New Chancellor — And Possible A Vice-Chancellor — To Be Selected

On April 25, Chancellor William B. Chandler III formally notified the Governor that he will be retiring.  The Chancellor has been serving on the Court of Chancery since 1989, and it will be hard to imagine the Court without his presence.

That leaves the Court with a vacancy for the Chancellor position.  If, as has been speculated, a Vice Chancellor were to apply and be selected, a Vice Chancellor position would subsequently open up.  So this could be an eventful year for Court of Chancery appointments.

In Delaware, candidates apply to a Judicial Nominating Committee, which selects three names to forward to the Governor.  Andre G. Bouchard, a well-known corporate litigator at the boutique firm of Bouchard, Margules & Friedlander, P.A., currently chairs the committee.  The Governor typically chooses one of the three to nominate, after which the nomination is forwarded to the Delaware Senate.

Because of Delaware constitutional requirements of political balance, if the nominee is not a current Vice Chancellor or Delaware Supreme Court justice, the nominee must be Republican.  Of course, if a Democratic former Vice Chancellor were confirmed as Chancellor, his replacement would then have to be a Republican.

Interestingly, though, for the Court of Chancery there is no requirement of political balance.  Thus, while the Chancellor resides in Sussex County, his replacement can be from any Delaware county.

Filed under: Court of Chancery

Special Counsel Files Chancery Brief On Collusive Settlements

In Scully v. Nighthawk, Special Counsel appointed (unusually) by the Court filed a brief on March 11 addressing the general issue of “reverse auctions” in multidistrict litigation (in which counsel for both sides in class actions in multiple fora have a possible incentive to proceed in the forum anticipated to approve the lowest-cost settlement).  While likely not the last word on these issues (the Court has yet to rule), the brief sets a high bar to a holding that a settlement was “collusive”.  But it states that the Delaware Court “should” ensure that all courts have equal access to information and can police this issue by, among other things, requiring that defendants disclose to the settlement court Delaware materials such as opinions or transcripts, or by contacting the settlement court itself.

The brief also proposes a new Chancery rule requiring such disclosures.  Special Counsel, veteran Delaware corporate litigator Gregory P. Williams of Richards, Layton & Finger, is also Chair of the Court of Chancery Rules Committee; he intends to ask the Court whether the Committee should consider such a rule.  The brief is available here (RLF associate Blake Rohrbacker assisted); the transcript of Vice Chancellor J. Travis Laster discussing the issue and appointing Special Counsel here.

Filed under: Class Actions, Collusive Settlements, Court of Chancery, Settlements

Chancery Refuses to Pull Airgas Poison Pill

On Tuesday the Court of Chancery issued a post-trial opinion ending the takeover battle of Air Products and Chemicals, Inc. for Airgas, Inc. (available here).  The Court refused to invalidate a poison pill which had already given Airgas “more time than any litigated poison pill in Delaware history” (emphasis in opinion).  In summary, while the Court expressed its personal disagreement with defensive measures being justified solely by the risk that stockholders might mistakenly disagree with a board’s view of a company’s value (a concept known as “substantive coercion”), it held itself bound by Delaware Supreme Court precedent to hold otherwise.  Air Products has stated that it will not appeal the opinion.  The opinion emphasizes the difficulty of persuading the Court of Chancery to pull a pill so long as a proxy fight to replace the target’s board is a realistic option for the bidder.

A summary of this lengthy and nuanced opinion follows below.

Air Products had made its “final” tender offer to Airgas’s stockholders of $70 per share in cash and fully financed.  The Airgas board, including three directors Air Products itself had nominated, refused to redeem its poison pill.  It did so not to proceed with any other alternative  transaction, but to continue its pre-existing business plan under the belief that Airgas executing this plan was worth substantially more, at least $78 per share.

Chancellor William B. Chandler III expressed his “personal view” that the pill had “served its legitimate purpose”.  The Court applied the customary Unocal test for defensive measures under the circumstances.  The Chancellor agreed “theoretically” with previous Chancery opinions that “the risk that the stockholders will mistakenly accept an underpriced offer because they disbelieve management’s representation of intrinsic value” did not justify a defensive measure once enough time had passed for the board to be able to tell its side of the story effectively.  But the Court held it was bound by Supreme Court precedent, including Paramount Communications, Inc. v. Time, Inc., 571 A.2d 1140 (Del. 1990), to hold otherwise.

The Court held that the board had conducted a good faith, reasonable investigation in rejecting the bid.  All but one were independent directors.  Airgas procured advice from three financial advisors.  And Air Products’ own nominees had, in the end, agreed with Airgas that the offer was inadequate.

The Court noted that almost half the stockholder base was now arbitrageurs (or “arbs”).  Because of this, it found “sufficient evidence that a majority of stockholders might be willing to tender their shares regardless of whether the price is adequate or not”.  The Court cited an example of one arb who had endorsed a deal when the offer was only $65.50, stating that the arb seemed ready “to see a deal done at any price” above his purchase price.  Airgas’s CEO testified that he had initially tried to convince the arbs of Airgas’s real long-term value but gave up after he became convinced that the arbs did not care.  Air Products’ own expert testified that large numbers of the arbs would tender their shares regardless of long-term value.  The Court called this a “new facet of substantive coercion,” different from the risk recognized in Paramount.

Other than getting the Court to pull the pill or walking away, Air Products had principally two options.  It could have called for a special meeting at which a supermajority (67%) vote could replace the board, or wait eight months for the next annual meeting of Airgas’s staggered board.  At the latter meeting, should its nominees prevail, it would have elected a majority of the Airgas board (although Air Products’s first three nominees had “changed sides” so to speak).

The Court held that the latter at least was a realistic possibility for Air Products.  The Court recognized that at some point, it could be argued, delay could mean denial for typically time-sensitive tender offers, and that no tender offeror had ever persisted through two annual meetings.  Nevertheless, the Court again held itself bound by Supreme Court caselaw to hold this to be a realistic option for Air Products, thus rendering the defensive measures, including the poison pill, not “preclusive” or “coercive” under the Unocal analysis.

The Court discussed a hypothetical scenario, called the “Effective Staggered Board” (or “ESB”) previously posed by Vice Chancellor Leo E. Strine, Jr., in which a poison pill was “plausibl[y]…preclusive”.   In the ESB, a bidder wins a first proxy contest as to a staggered board but is forced by the incumbent majority to suffer the economic risks of maintaining its bid for another year before the second contest.  The Court noted that Airgas was not this case given that, for one, Air Products’ own nominees had changed sides.

The Court states that a board “cannot ‘just say no’” to a tender offer.  Given the Court’s recognition of a broad view of substantive coercion, however, acquirers are limited in their options when a board does finally say no.  Such a board is subject largely to a process-based review – whether it was “acting in good faith, after reasonable investigation and [at least in this case] reliance on the advice of outside advisors”.  So long as a proxy contest is a realistic possibility for an acquirer, it will be difficult to persuade a Delaware court to redeem a pill, even one in place as long as this one. 

Filed under: Court of Chancery, Poison Pill, Unocal

Chancery Bars Derivative Actions By Creditors Of LLCs and LPs

For several years it has been established that creditors of Delaware corporations have standing to bring derivative actions when the debtor corporation is insolvent.  A recent Court of Chancery opinion, however,  CML V, LLC v. Bax, C.A. No. 5373-VLC (Del. Ch. Nov. 3, 2010), has held that that is not the case with respect to Delaware  limited liability companies (LLCs) – and implicitly Delaware limited partnerships (LPs).

In 2007, the Delaware Supreme Court had held that creditors had standing to bring derivative actions in the name of debtor insolvent Delaware corporations.   N. Am. Catholic Educ. Prog. Found., Inc. v. Gheewalla, 930 A.2d 92, 101 (Del. 2007) (“Gheewalla”).  Late last year, the Court of Chancery held in Bax that creditors of Delaware LLCs cannot bring such derivative actions.  The Court did so based on a provision of the Delaware LLC Act requiring contemporaneous ownership of membership interests.  6 Del. C. § 18-1002.  Section 18-1002, unlike the equivalent corporation law provision,  states that plaintiff “must” be a “member or an assignee” of the LLC “at the time of the transaction of which the plaintiff complains” (known as the contemporaneous ownership requirement).  The Delaware LP Act contains substantively identical language.  While the Delaware General Corporation Law also contains a contemporaneous ownership provision, it is not worded to expressly require a derivative plaintiff to be a stockholder.  See 8 Del. C. § 327 (“In any derivative suit instituted by a stockholder of a corporation, it shall be averred in the complaint that the plaintiff was a stockholder of the corporation at the time of the transaction . . . .).

The Court was apparently not entirely comfortable with either of the two conflicting rules of Delaware law from which the holding in Bax resulted.  Vice Chancellor J. Travis Laster noted his prior criticism of the contemporaneous ownership requirement.  In justifying its decision, the Court noted the methods LLC creditors have to protect themselves, such as requiring protection in an LLC agreement.  The Court also referenced the criticism of creditor derivative standing itself by another member of the Court, though acknowledging that such standing is now the law under Gheewalla at least with respect to insolvent Delaware corporations.

Filed under: Court of Chancery, Derivative Actions, Derivative Standing

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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.