Delaware Corporate Law Update

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

Supreme Court Reverses Denial of Contractual Fee-Shifting

In Washington v. Preferred Communication Systems, Inc., (opinion available here), decided February 27, the Delaware Supreme Court reversed the Court of Chancery and awarded attorneys’ fees pursuant to a promissory note fee-shifting provision.

In 2006, appellants bought promissory notes issued by appellee Preferred Communication Systems, Inc. (“PCSI”). When the notes came due in 2007, PCSI was unable to pay. PCSI agreed in an offer letter to provide noteholders with stock warrants as compensation for delay until it could pay.

In 2013, after PCSI received a significant cash payment, noteholders sued PCSI in Texas. The parties ultimately settled the noteholders’ claims for outstanding principal and interest but agreed to litigate their claims for warrants in Delaware. The Court of Chancery granted summary judgment in favor of the noteholders, holding, “The contract at issue consists of the Notes as modified by the Offer Letter” and that PCSI had breached the contract by not issuing the warrants.

The successful noteholders then sought attorneys’ fees pursuant to a fee-shifting provision in the promissory notes. The provision shifted fees if “any indebtedness” evidenced by the notes was collected in a court proceeding; or if the notes were “placed in the hands of attorneys for collection after default”. The Court of Chancery denied the motion, holding that “fee-shifting rights extend only to collection efforts.”

On appeal, the noteholders argued that “indebtedness” was a broad term that included warrants as well as principal and interest; and that PCSI had defaulted by not issuing the warrants. The Supreme Court agreed with the noteholders that the plain language of the notes shifted fees, emphasizing the Court of Chancery’s summary judgment ruling that the offer letter had modified the notes (which contained the fee-shifting provision) to promise warrants. The Supreme Court also held that even if the promissory notes had been ambiguous, they would have been construed against drafter PCSI under the contra proferentem doctrine. Thus, the Court reversed and remanded to the Court of Chancery to award attorneys’ fees.

The Williford Firm LLC served as Delaware counsel for appellants-noteholders in this action.

Filed under: Attorneys' Fees, Delaware Supreme Court

Close Board Ties And A Shared Airplane Eliminate Independence

Earlier this month Chief Justice Strine authored an opinion (Sandys v. Pincus) holding that close ties among certain board members, including co-owning an airplane, caused key directors to be non-independent.  Therefore, the Delaware Supreme Court reversed Chancery’s grant of a motion to dismiss derivative claims for plaintiff not having demanded that the board bring them.

Plaintiff alleged that top managers and directors of Zynga Inc. breached their fiduciary duties by selling stock while in possession of non-public information which, when it became public later, caused Zynga’s stock price to drop some 74%.  After quickly concluding three of Zynga’s nine directors were interested or non-independent, Sandys primarily concerns three additional directors:  Ellen Siminoff, William Gordon, and John Doerr.

Plaintiff alleged that Siminoff and her husband co-owned an airplane with interested director Pincus (Zynga’s Chairman, controlling stockholder, and former CEO) and that she was a “close family friend” of that director.  The Court criticized plaintiff for not getting more information about the relationship, either in a books and records lawsuit plaintiff had previously filed against Zynga or simply from a search engine such as “the tool provided by the company whose name has become a verb”.  Nevertheless, the Court held Siminoff lacked independence because joint plane ownership was “suggestive of the type of very close personal relationship that, like family ties, one would expect to heavily influence a human’s ability to exercise impartial judgment.”

Plaintiff alleged a number of facts about Gordon and Doerr including that (1) both are partners in Kleiner Perkins, a venture capital firm that controls 9.2% of Zynga’s stock; (2) Kleiner Perkins invested in a company co-founded by Pincus’ wife; and (3) Kleiner Perkins had invested in and obtained board seats at another company with another interested director.  Moreover, the board had determined Gordon and Doerr non-independent for purposes of rules promulgated by the NASDAQ stock exchange.  The Court again criticized plaintiffs for not seeking additional information including the reasons for the NASDAQ determination.  Nevertheless, it ruled Gordon and Doerr non-independent where alleged facts suggest directors belong to “networks [that] arise of repeat players who cut each other into beneficial roles in various situations” and where the board itself has determined them non-independent.  Conversely, it held that plaintiffs need not plead a “detailed calendar of social interactions”.

Justice Valihura authored a (uncommon though certainly not unheard of) dissent.  As to Gordon and Doerr, Valihura cited the lack of pled facts on the size or materiality of the ties or the relevant reasons for the NASDAQ determination.  As to Siminoff, Valihura pointed to plaintiff’s own description of the shared airplane as evidencing a “business” relationship as insufficient to result in non-independence.

Key take-aways:

  • The Court did not announce a new standard on when close business or personal ties result in non-independence. Nevertheless, Sandys could lead to Delaware courts being more willing to hold directors non-independent in close cases involving specific pleaded facts that reasonably suggest possible bias.
  • It behooves all lawyers to use search engines in light of the massive amount of information available online, including before filing complaints. The Court cautions lawyers to use them to find information of a “reliable” nature such as “articles in reputable newspapers and journals, postings on official company websites, and information on university websites”.
  • The appeal concerned a motion to dismiss ruling using a somewhat plaintiff-friendly standard. Delaware courts will be more skeptical as to whether – after trial – a plaintiff has proven a director non-independent for purposes of invoking the stringent entire fairness standard.
  • Plaintiffs seeking pre-lawsuit books and records should consider asking for information about director independence if that issue is potentially relevant.

Filed under: Delaware Supreme Court, Demand Futility, Derivative Actions, Director Independence, Fiduciary Duties, Section 220 Books and Records

Chancery Court Denies Law Firm’s Charging Lien

In Sutherland v. Sutherland (opinion available here), Vice Chancellor Noble rejected a petition by law firm Katten Muchin Rosenman LLP (“Katten”) for a charging lien against an attorneys’ fee award where the allegedly unpaid bill solely related to work after the work on which the fee award was based.

The litigation, which began in 2004 and 2006, resulted in certain benefits to the subject company; namely, elimination of salary to certain persons terminated for cause and modification of provisions allowing insiders to compete with the company.  The Court awarded $275,000 in fees for those benefits, all of which were achieved by 2007.

Katten had represented plaintiff in the litigation.  Katten, which had already been paid $2.7 million, claimed it was still owed $766,166.75 for work occurring after 2008.

As the Court noted, the purpose of a charging lien is “to make sure that the client does not avoid paying her lawyer for the benefits she obtained”.  It held that Katten, however, was seeking a charging lien “for work which caused no benefit and has no connection to the recovery, other than having occurred in the same litigation.”  Thus, the Court rejected the petition: “Seeking a charging lien for work which produced no benefit when the law firm has already been paid for the work which produced the benefit (whether the benefit for the family corporation or the corresponding fee award) is inconsistent with the theoretical underpinnings of the attorney’s charging lien.”

N.B.  Since the publishing of this post, on January 3, 2017, the Delaware Supreme Court reversed the Court of Chancery’s opinion.

The Williford Firm LLC served as Delaware counsel for plaintiff in this action.  Results in cases depend on their specific factual and legal circumstances and results in one do not guarantee the same or similar results in another.

Filed under: Court of Chancery, Delaware Supreme Court

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

Justice Ridgely On Certifying Questions to the DE Supreme Court

For those litigating cases outside of Delaware involving novel issues of Delaware law, one option not always apparent is that of requesting that court to certify the question to the Delaware Supreme Court. Justice Henry duPont Ridgely of the Delaware Supreme Court recently published an essay in the SMU Law Review that discusses this option, noting that it can save other courts from having to guess how the Delaware Supreme Court would rule.  It has been posted on the Delaware Corporate and Commerical Litigation Blog here.

The Delaware Constitution permits the Delaware Supreme Court to hear questions certified to it from other Delaware  (e.g. trial) courts; the United States Supreme Court, Court of Appeals, or District Court; another state’s highest appeals court; and the SEC.  Del. Const. Art. IV, § 11(8).  According to Justice Ridgely, it is also “likely” that a federal bankruptcy court could certify a question based upon the general grant of power to receive questions from a US District Court.

Supreme Court Rule 41(b) provides that certification is to be accepted at the Court’s discretion “only where there exist important and urgent reasons for an immediate determination by this Court”.  Material facts cannot be in dispute.  Rule 41(b) lists “illustrate[d] reasons” for accepting a certified question, including that a novel Delaware question of law is involved, trial court decisions are in conflict, and there is an unsettled question involving a Delaware statute or constitutional provision.

Justice Ridgely sets forth statistics regarding accepted certified questions, including from the US Court of Appeals, a number from the US District Court of Delaware, four from other states’ US District Courts, and one from the SEC.  Interestingly, none are from the highest courts of other states.  According to Justice Ridgely, the Supreme Court is more likely to accept certified questions from foreign fora than from Delaware trial courts.

Filed under: Certified Questions, Delaware Supreme Court

Supreme Court Sets Standard For Preliminary Injunction Security

One of the practicalities of a motion for preliminary injunction is that the party enjoined may request the other side provide security for damages resulting from the injunction should it later be determined to have been wrongfully granted.  The standard governing such a request has, however, rarely been the subject of a written opinion in Delaware.  A recent opinion from the Supreme Court,  Guzzetta v. Service Corporation of Westover Hills, No. 34, 2010 (Del. Nov. 9, 2010) (attached), sheds some light on this subject.

Court of Chancery Rule 65(c) requires a party seeking an injunction to provide security “for the payment of such costs and damages as may be incurred or suffered by any party who is found to have been wrongfully enjoined.”   (Security typically takes the form of a bond, often costing only a small portion of its face amount).   In Guzzetta, the Court had granted a bond ultimately in the amount of $10,000, rejecting defendants’ request for a significantly higher one.  The Court ultimately determined the injunction to have been wrongfully granted and awarded defendants the amount of the bond.

The amount of the security sets the ceiling for damages the enjoined party may recover should the trial court ultimately rule in that party’s favor.  Thus, Guzzetta states that the trial court should “err on the high side” and set bond in an amount “likely to meet or exceed a reasonable estimate of potential damages.”  The Court noted, however, that the party seeking the bond must support its application with “facts of record or . . . some realistic as opposed to a yet-unproven legal theory from which damages could flow to the party enjoined.”  The Court held that, “If necessary,” the trial court could hold an evidentiary hearing to determine whether there was “some credible basis” for the estimated damages.

In applying that standard to the case at bar the Court affirmed the trial court’s rejection of certain items of possible damage as without merit.  The trial court had not explained, however, why it had rejected other items totaling more than twice the amount of the bond granted.  The Court thus reversed and remanded for further proceedings in light of its opinion.

Filed under: Delaware Supreme Court, Preliminary Injunction, Security

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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.