Delaware Transactional Law Updates

Document: Orix LF, LP v. Inscap Asset Management, LLC, et al., C.A. No. 5063-VCS, Strine, V.C. (Del. Ch. April 13, 2010)

Plaintiff was a member of ISM Advisors, LLC (the “LLC”), which was formed for the purpose of owning an interest in, and managing, an investment fund in the life insurance new issues market (the “Fund”).  Planitiff was permitted to appoint one of two co-CEOs of the LLC, and caused its CEO to resign.  Plaintiff did not replace its co-CEO.  Defendants initiated arbitration proceedings against plaintiff pursuant to the terms of the LLC’s operating agreement and the Fund’s operating agreement.  Plaintiff brought suit to enjoin arbitration proceedings brought by defendants.  The Court held that pursuant to Delaware precedent in James & Jackson, LLC v. Willie Gary, LLC, 906 A.2d 76 (Del. 2006) and McLaughlin v. McCann, 942 A.2d 616 (Del. Ch. 2008), when the parties indicate in an agreement to arbitrate “any” disputes “arising under or relating to” the agreement, “so long as the defendants have a colorable argument that their claims are arbitrable, the arbitrator – not this court – must determine the ultimate question of substantive arbitrability.”  Pursuant to Willie Gary, the Court also stated that “clear and unmistakable evidence” of the intent of the parties to arbitrate exists when “the contract generally refers all disputes to arbitration” and “the contract refers to a set of rules that would empower arbitrators to decide arbitrability.”  Further, following the precedent of Willie Gary, the Court held that matters of procedural arbitrability were also to be decided by an arbitrator.  Consequently, the Court dismissed the plaintiff’s complaint without prejudice, holding that it lacked subject matter jurisdiction.

Document: Nemec v. Shrader, Del. Supr., Nos. 305, 2009 and 309, 2009 (Del. Supr. Apr. 6, 2010)

This Delaware Supreme Court opinion affirms the Court of Chancery’s decision dismissing plaintiffs’/appellants’ claims that the defendants/appellees breached their implied duty of good faith and fair dealing when they elected to redeem the plaintiffs’ shares of the corporation’s stock pursuant to the corporation’s Officers Stock Rights Plan rather than allowing them to achieve a greater return by allowing the stock to remain outstanding so that it be cashed out for a more favorable price pursuant to the terms of a pending merger.  The Court’s opinion emphasizes the fact that tremendous weight is to be afforded to the terms of a freely negotiated contract and that the duty of good faith and fair dealing must take a back seat to the terms of the contract when the contract in question expressly addresses the issue at hand so as not to allow a party to use this fiduciary duty principle as a mechanism for effectively renegotiating the terms of what it may consider to be a “bad deal.”  The Court also highlighted a statement made by the Court of Chancery in its opinion below where it noted that “[c]ontractually negotiated put and call rights are intended by both parties to be exercised at the time that is most advantageous to the party invoking the option.”  Finally, it is noteworthy that two of the five justices issued a rare dissenting opinion, which asserted that although it is correct that a party does not act in bad faith by relying on contract provisions that it bargained for, even if the result is to eliminate advantages that the counterparty would otherwise receive, in order to avoid running afoul of the implied covenant of good faith and fair dealing, the challenged conduct must also further a legitimate interest of the party acting in reliance of the contract.

Document: OneScreen, Inc. v. Hudgens, C.A. No. 4545-VCP (Del. Ch. March 30, 2010)

Plaintiff corporation sought to rescind a stock transfer arising out of a loan that was allegedly criminally usurious under Florida law.  In a ruling that clarified Delaware law with respect to personal and jurisdiction over stockholders of Delaware corporations and in rem jurisdiction over the stock that they own, the Court of Chancery held that the United States Supreme Court’s ruling in Shaffer v. Heitner generally prevents the Court from exercising in rem jurisdiction in situations where the sole connection to Delaware is the fact that the entity that issued the stock is a Delaware corporation.  The Court did note that there is a narrow exception to this general rule, which would allow for in rem jurisdiction in situations where the dispute is related to the legal existence of the stock or its character or attributes.  That exception did not apply here due to the fact that the plaintiff’s rationale for asking the Court to invalidate a stock transfer stemmed from an alleged violation of a Florida criminal statute that did not implicate the corporate process or the validity or attributes of the corporation’s stock.

Document: Fletcher Int’l, Ltd. v. ION Geophysical Corp., C.A. No. 5109-VCP, Parsons, V.C. (Del. Ch. March 24, 2010)

Plaintiff sought partial summary judgment with respect to its claim that it had the right to consent to the issuance of any security of a subsidiary of defendant ION Geophysical Corp. (“ION”), and specifically the issuance by ION through a wholly-owned subsidiary of a convertible promissory note (the “Note”).  Plaintiff sought, as relief, a declaration that the note was invalid and a return to ION of the funds borrowed under the Note.  The Court treated the requested relief as a motion for injunctive relief.  Although the Court found that plaintiff had shown a reasonable probability of success on the merits, the Court found that plaintiff had not made a strong showing of irreparable harm and that the balance of equities weighed in favor of defendants.  Accordingly, the Court denied the motion for partial summary judgment to the extent it was requesting preliminary injunctive relief.

Document: Kuroda v. SPJS Holdings, L.L.C., C.A. No. 4030-CC, Chandler, C. (Del. Ch. March 16, 2010)

In the second opinion rendered in this matter involving plaintiff’s claim for money pursuant to a limited liability company agreement, the Court considered plaintiff’s motion to dismiss defendants’ counterclaims against plaintiff for breach of the implied covenant of good faith and fair dealing and breach of contract claims, as well as breach of fiduciary duty claims.  The Court granted plaintiff’s motion, finding that plaintiff had no fiduciary duties since he was neither a manager nor controlling member of the subject LLC, and could not be liable for breach of contract because he was not party to the contracts upon which defendants based such counterclaims.  The Court also stated, in dismissing the implied covenant claims under the LLC agreement, that the implied covenant “cannot be invoked to override the express terms of the contract”.

Document: London, et al. v. Tyrrell, et al. and MA Federal, Inc., C.A. No. 3321-CC, Chandler, C. (Del. Ch. March 11, 2010)

After investigation of plaintiffs’ derivative claims, a special litigation committee (“SLC”) formed by nominal defendant MA Federal, Inc. recommended dismissal of this action.  The Court denied the SLC’s motion to dismiss because there were material questions of fact regarding the SLC’s independence, its good faith in investigating the claims, and the reasonableness of its grounds to dismiss.  Specifically, the Court focused on, inter alia, the familial and professional relationships between the members of the SLC and defendant Tyrrell, the fact that the SLC members appeared to have reviewed the merits of the claims before the SLC was formed, that the SLC determined that duty of care claims should be dismissed based on Section 102(b)(7) of the DGCL when part of the relief sought was injunctive in nature, and that based on the allegations, the scope of the SLC’s investigation of the duty of loyalty claims was not adequate and the SLC did not have a reasonable basis for its findings.

Document: LC Capital Master Fund, Ltd. v. James, et al.,  C.A. No. 5214-VCS, Strine, V.C. (Del. Ch. March 8, 2010)

Plaintiff, a preferred stockholder of QuadraMed Corporation, sought to enjoin the acquisition of QuadraMed on the grounds that the consideration to be received by the preferred stockholders did not exceed the “as if converted value” they were allegedly entitled to demand in a merger.  Based on those contractual rights, the plaintiff asserted that the QuadraMed board had a fiduciary duty to allocate more of the merger consideration to such preferred stockholders.  The Court found that plaintiff did not prove a probability of success on the merits.  Specifically, the Court found that when a certificate of designation does not provide preferred stockholders with the right to vote on a merger or a liquidation preference in a merger, but with a contractual right to certain treatment, a board that allocates consideration consistent with such contractual rights need not ordinarily do more.

Teachers’ Retirement System of Louisiana v. PricewaterhouseCoopers LLP, No. 454, 2009 (Del. Supr. March 4, 2010)
In a case involving allegations that the defendant/appellee failed to perform its auditing responsibilities in accordance with professional standards of conduct and thus failed to detect or report the fraud perpetrated by AIG’s senior officers in connection with the events that caused the much-publicized near-collapse of that company, the appellant (derivative plaintiff below) appealed the Court of Chancery’s holding that, based on New York law, once the wrongdoing was imputed to AIG, AIG’s derivative claims against PricewaterhouseCoopers LLP were barred by New York’s in pari delicto doctrine.  Based on Section 500.27 of the New York Rules of Court, which permits a court of last resort of any other state to certify questions to the New York Court of Appeals when confronted with questions of New York law for which no controlling precedent of the New York Court of Appeals exists, the Delaware Supreme Court has certified the following question of law to the New York Court of Appeals:

Would the doctrine of in pari delicto bar a derivative claim under New York law where a corporation sues its outside auditor for professional malpractice or negligence based on the auditor’s failure to detect fraud committed by the corporation; and, the outside auditor did not knowingly participate in the
corporation’s fraud, but instead, failed to satisfy professional standards in its audits of the corporation’s financial statements?

Document: Pfeiffer v. Toll, et al. and Toll Brothers, Inc., C.A. No. 4140-VCL, Laster, V.C. (Del. Ch. March 3, 2010)

Plaintiff brought this derivative action for damages allegedly suffered by nominal defendant Toll Brothers, Inc. as a result of alleged insider trading by the individual defendants.  Defendants moved to dismiss the action and the Court denied the motion.  Plaintiff’s claims were brought as breach of fiduciary claims and a claim for contribution and indemnification.  Defendants based their motion to dismiss on the grounds that the complaint did not comply with Court of Chancery Rule 23.1 (alleging demand futility) and statute of limitations regarding the stock sales and, with respect to the outside director defendants, adequately plead a breach of fiduciary duty claim.  Since all of the individual defendants were named in a federal securities action which had survived a motion to dismiss, the Court found that the complaint here satisfied Rule 23.1. The Court also found that the complaint adequately pled a tolling of the three-year statute of limitations and adequately pled a breach of fiduciary claim against the outside directors.  Finally, the Court rejected defendants’ argument that Brophy v. Cities Service Co., which recognizes a claim for breach of fiduciary duty for insider trading, is no longer good law.

Document: Edgewater Growth Capital Partners, L.P., et al. v. H.I.G. Capital, Inc. et al., C.A. No. 3601-VCS, Strine, V.C. (Del. Ch. March 3, 2010)

Plaintiff shareholders of ATM Acquisition Corporation (“ATM”) filed suit alleging, inter alia, that defendant directors of ATM aided and abetted in fraudulent transfer of ATM’s assets to only bidder.  Plaintiffs’ complaint alleged both “subjective” fraudulent transfer (“actual intent to hinder, delay or defraud…a creditor of [ATM]”) and “constructive” fraudulent transfer (defendants caused a transfer which caused ATM to fail to receive reasonably equivalent value in exchange), pursuant to the Delaware Uniform Fraudulent Transfer Act, 6 Del.C. Section 1301 et seq.  The Court, on both statutory interpretation grounds and reliance on precedent set in Trenwick America Litigation Trust v. Ernst & Young, LLP, 906 A.2d 168 (Del.Ch. 2006), aff’d 931 A.2d 438 (Del. 2007), granted motion to dismiss on counts relating to fraudulent transfer claims, holding that “the [DUFTA] does not create a cause of action for aiding and abetting, or conspiring to commit, a fraudulent transfer,” and that the DUFTA only permits an action “by a creditor against debtor-transferor or transferees.”

Document: PT China LLC v. PT Korea LLC, et al., C.A. No. 4456 – VCN, Noble, V.C. (Del. Ch. Feb. 26, 2010)

In this case involving claims by members and managers of a Delaware limited liability company (the “LLC”), a third-party defendant who was a manager of the LLC claimed the Court lacked personal jurisdiction over him.  The Court held that it had personal jurisdiction over the third-party defendant manager pursuant to Section 18-109 of the Delaware Limited Liability Company Act (the “Act”).  Section 18-109 of the Act provides for service of process on managers of Delaware LLCs.  The Court noted, that if one is served under 18-109, personal jurisdiction must still be consistent with due process, which is satisfied when the action relates to a violation by the manager of fiduciary duty owed to the LLC.  The Court found that the allegations against the third party defendant were sufficient to support claims of breach of fiduciary duty.  The Court also held that Section 18-109 was the basis, based on the facts alleged, to confer personal jurisdiction on the Court with respect to breach of contract claims.

Document: Selectica Inc. v. Versata Enterprises, Inc., et al., C.A. No. 4241-VCN, Noble, V.C. (Del. Ch. Feb. 26, 2010)

This action arises out of the adoption of a rights agreement or “poison pill” by the plaintiff company’s Board in order to preserve certain net operating loss carryforwards (“NOLs”) perceived to be at risk as a result of share purchases by defendant Trilogy, Inc.  Plaintiff Selectica sought declaratory judgment that the Board’s actions in adopting the pill, a subsequent exchange of shares, and the adoption of a revised and “reloaded” pill were valid and proper.  The Court found that there was sufficient evidence to find good faith and reasonable investigation by the board under the first prong of Unocal (reasonable grounds for believing a threat to corporate policy and effectiveness), that the Board was reasonable in concluding that the NOLs were worth preserving, that Trilogy posed a threat, and that the Board’s actions were reasonable in response to the perceived threat.  Therefore, the Court found the actions were a valid exercise of the Board’s business judgment.

Document: Kelly v. Blum, et al., C.A. No. 4516 – VCP, Parsons, V.C. (Del. Ch. Feb. 24, 2010)

This action, brought as an individual and derivative action on behalf of the nominal defendant limited liability company (“LLC”), challenged a merger involving the LLC.  Plaintiff sought a declaratory judgment that the merger was void and also alleged breach of contract and fiduciary duties, breach of the implied covenant of good faith and fair dealing and defamation.  The Court considered plaintiff’s motion for partial summary judgment that the merger was invalid for failure to comply with notice provisions of the LLC agreement and seeking to restore him as a member and manager of the LLC.  The Court also considered defendants’ motion to dismiss all counts of plaintiff’s complaint.  The Court found that the LLC agreement permitted the merger and the merger was not void for failure to comply with the LLC notice requirements. Thus, plaintiff could not sue derivately as he lost his standing as a result of the merger.  The Court granted defendants’ motion to dismiss certain of the counts and plaintiff withdrew certain counts, but the Court denied the motion as to plaintiff’s breach of fiduciary duty and aiding and abetting breaches, as well as his defamation claim.

Document: Whittington v. Dragon Group L.L.C., et al., C.A. No. 2291-VCP, Parsons, V.C.  (Del. Ch. Feb. 15, 2010)

This matter was on remand from the Delaware Supreme Court, which had reversed the Court of Chancery’s holding that a three-year statute of limitations was applicable by analogy in dismissing plaintiff’s claims based on laches.  The Court, in applying by analogy the twenty-year statute of limitations directed by the Supreme Court, held that plaintiff’s claims were not barred by laches.

Document: Kurz, et al. v. Holbrook, et al., C.A. No. 5019-VCL, Laster, V.C. (Del. Ch. Feb. 9, 2010)

After trial, the Court ruled on the parties competing requests for relief under Section 225 of the DGCL as to the composition and control of the Board of EMAK Worldwide, Inc. (“EMAK”).  Plaintiffs contended that sufficient stockholder consents were delivered to remove two of a five person board with two vacancies and fill three vacancies, thereby giving their group control of the board.  Defendants claimed their group delivered sufficient consents to amend EMAK’s by-laws to, among other matters, set the number of directors at three.  With the ability to name two directors under the terms of preferred stock, defendants could gain control of the board.  The amended by-laws also provided that if the number of sitting directors exceeded three, a special meeting of stockholders would be held to elect the third director who would be the single successor. The Court held the by-laws to be void as in conflict with the DGCL, and that the Plaintiffs consents validly provided them with control of the Board.  Specifically, the Court found that the by-laws sought to shrink the board below the number of sitting directors, which was in conflict with the DGCL.

Document: Great American Opportunities, Inc. v. Cherrydale Fundraising, LLC, et al., C.A. No. 3718-VCP, Parsons, V.C. (Jan. 29, 2010)

This action involved claims by plaintiff, the acquiror of substantially all of the assets of Kathryn Beich Inc. (“KB”), against third party Cherrydale for tortious interference with contract and misappropriation of trade secrets.  The Court found that certain of Cherrydale’s agents engaged in conduct which amounted to tortious interference with Great American’s contractual relationships with three former KB employees.  The Court also found that Cherrydale willfully and maliciously misappropriated Great American’s trade secrets.  However, since Great American largely failed to prove damages, it was awarded limited damages for the tortious interference claim, an equal amount of exemplary damages for the misappropriation claim, and one-half of its attorneys’ fees.

Document: Harris v. RHH Partners, LP, et al., C.A. No. 1198-VCN, Noble, V.C. (Jan. 27, 2010)

Petitioner Harris sought to have the general partner of a limited partnership in which he was the sole limited partner and held a 99% interest replaced or have the partnership dissolved. The partnership’s sole asset was Harris’ personal residence.  The Court found that notwithstanding the general purpose clause in the partnership agreement, there was no apparent purpose for the partnership, rejecting Intervenor Hartman’s claim that it was established to secure obligations owed by Harris to Hartman.  Accordingly, the Court ordered dissolution of the partnership and held that the general partner of the partnership, which was controlled by Hartman, would have a one-percent undivided fee simple interest in the Harris property and Harris would have the remaining ninety-nine percent undivided fee simple interest in the property.

Document: Amirsaleh v. Board of Trade of the City of New York, et al., C.A. No. 2822-CC, Chandler, C. (Jan. 19, 2010)

After trial, the Court found that defendants’ conduct did not constitute bad faith and therefore was not a breach of the implied covenant of good faith and fair dealing.  The dispute arose out of the merger of New York Board of Trade (“NYBOT”) with a wholly-owned subsidiary of Intercontinental Exchange, Inc. (“ICE”).  In connection with the merger, NYBOT owners were given the option of being cashed out or receiving cash and ICE stock.  The preference needed to be set forth in an election, which if not submitted timely, would result in an owner being cashed out.  Although NYBOT determined to accept late elections not submitted by the initial deadline, it determined to close the late election window after which plaintiff submitted its form.  Plaintiff pursued its claim of breach of the implied covenant of good faith and fair dealing in connection with the decision to close the late election window.  Plaintiff, however, failed to establish bad faith by showing that the decision was motivated by an improper purpose.

Document: Robotti & Co., LLC v. Liddell, et al. and Gulfport Energy Corp., C.A. No. 3128-VCN, Noble, V.C. (Del. Ch. Jan. 14, 2010)

The Court granted the defendants’ motion to dismiss this class and derivative action which challenged a stockholder rights offering.  The plaintiff claimed that the defendant directors set the offering at an inadequately low price so as to trigger anti-dilution provisions in their stock option agreements and the controlling shareholder’s warrants.  The Court found that the anti-dilution provisions maintained unchallenged, pre-existing contractual rights which left the defendant directors in substantially the same position they were in prior to the offering.  The Court also found that the plaintiff did not sufficiently allege that the directors engaged in disloyal conduct.

Document: In Re the Dow Chemical Co. Derivative Litig., C.A. No. 4349-CC, Chandler, C. (Del. Ch. Jan. 11, 2010)

The Court granted dismissal of all of plaintiffs’ (Dow stockholders) derivative claims, which sought to recover losses on behalf of the Company arising out of a transaction with Rohm & Haas, for failure to properly plead demand futility under Chancery Court Rule 23.1. The breach of fiduciary duty claims which focused primarily on the substantive provisions of the merger deal with Rohm & Haas, such as the absence of a financing condition, and were based on an alleged failure to supervise by the director defendants, were dismissed with prejudice, but certain other claims were dismissed without prejudice because either plaintiffs abandoned the claims (insider trading and waste claims) or the claims were not ripe (contribution and indemnification claims).