Delaware Transactional Law Updates

Document: Benihana of Tokyo, Inc. v. Benihana, Inc., No. 36-2006, Berger, J. (Del. Aug. 24, 2006)

Affirmed Court of Chancery’s decision that preferred stock was authorized by the company’s certificate of incorporation and board’s approval of the issuance was a valid exercise of business judgment.

Document: Hillman v. Hillman, C.A. No. 1557-N, Strine, V.C. (Del. Ch. Aug 23, 2006)

Complaint seeking declaration that plaintiff remain a limited partner in a partnership after being removed as general partner was dismissed where the partnership agreement did not grant such a right.

Document: Kaufman v. CA, Inc., C.A. No. 699-N, Lamb, V.C. (Del. Ch. Aug. 23, 2006)

Motion to compel books and records under 8 Del. C. § 220 was denied; defendant had already provided substantial number of documents and the plaintiff failed to establish why further documents were needed for her proper investigative purpose.

Document: Wilcox & Fetzer, Ltd. v. Corbett & Wilcox, C.A. No. 2037-N, Parsons, V.C. (Del. Ch. Aug. 22, 2006)

Compeled arbitration of a trade name dispute based on an arbitration clause in a stock purchase agreement, notwithstanding the fact that defendant was not a party to the agreement — the scope of the arbitration clause was broad and the claim was interconnected with the rights granted in the agreement.

Document: Blue Chip Capital Fund II LP v. Tubergen, C.A. No. 1611-N, Lamb, V.C. (Del. Ch. Aug. 22, 2006)

Breach of fiduciary duty claims against directors relating to the amount of a preference distribution were dismissed, where complaint asserted viable contractual claims based on the same transaction and the rights were essentially contractual.

Documents: In re Grupo Dos Chiles, LLC, C.A. No. 1447-N, Parsons, V.C. (Del. Ch. Aug. 17, 2006)

Attorneys’ fees awarded to petitioner under the bad faith exception to the American rule, where the opposing party acted in bad faith – their position was (1) “strained and wholly at odds with the operative reality” of the situation and (2) “directly opposite” to facts averred in litigation proceeding in another forum.

Documents: Trenwick America Litig. Trust v. Ernst & Young, L.L.P., C.A. No. 1571-N, Strine, V.C. (Del. Ch. Aug. 10, 2006)

Granted motions to dismiss claims by litigation trust of a bankrupt insurance holding company, where the complaint did not adequately aver facts implying insolvency during disputed transactions or breach of fiduciary duties, and where litigation trust tried to assert direct creditor claims that had not been properly assigned to the trust.

Document: Wynnefield Partners Small Cap Value L.P. v. Niagara Corp., C.A. No. 1261-N, Parsons, V.C. (Del. Ch. Aug. 9, 2006)

Court denied defendant company’s motion to stay an order granting a §220 information request pending appeal, where plaintiff would lose standing from cash-out merger.

Document: Kosseff v. Ciocia, C.A. 188-N, Glasscock, Master (Del. Ch. Aug. 3, 2006)

Complaint stated a claim for breach of the duty of care where the board acted quickly and without the aid of outside advice.

Document: Facchina v. Malley, C.A. No. 783-N, Noble, V.C. (Del. Ch. Aug. 1, 2006)

Court declared that defendants had failed to establish that an LLC agreement was in place.

Documents: Paul S. Levy, et al. v. Hayes Lemmerz International, Inc., et al. Del. Ch., C.A. No. 1395-N (April 5, 2006)

The directors filed this suit seeking an order requiring both the old and new companies to indemnify them for their settlement expenses.  The defendants moved to dismiss that action pursuant to Court of Chancery Rule 12(b)(6).  The Court dismissed the plaintiffs’ claims as to the new holding company, which the Court found as a matter of law had no obligation to indemnify its predecessors’ former directors and officers.  However, the Court denied the motion to dismiss as to the old company.  Defendants argued that all counts against New Hayes should be dismissed because the plaintiffs were never directors of New Hayes.  Defendants moved to dismiss the complaint against both Old and New Hayes because, they argued, the plaintiffs had breached their indemnification agreements.  The outside directors never were directors of New Hayes, and never signed indemnification agreements with that entity.  The only remaining claims for indemnification, therefore, are against Old Hayes, by virtue of the plaintiffs’ indemnification agreements with that company, as authorized by the Old Hayes bylaws.  There is no indication that the indemnification provision requires the plaintiffs in this case to issue a written demand on Old Hayes.  The Court finds the indemnification agreements are clear that no written demand for indemnification is required.  The defendants claimed the Court should stay the plaintiffs’ indemnification action until the SEC concludes its investigation of the underlying accounting irregularities and financial restatements that gave rise to the class action.

Document: Big Lots Stores, Inc. v. Bain Capital Fund VII, LLC, et al. Del. Ch., C.A. No. 1081-N (March 28, 2006)

As the holder of the $45 million note, the selling corporation is the largest unsecured creditor in the bankruptcy proceeding.  The seller brings this action asserting claims based on a variety of legal theories including breach of fiduciary duties, fraud, and civil conspiracy.  The Court concluded that most of the plaintiff’s claims are barred as a matter of law because they are derivative in nature, not direct, and thus belong to the bankruptcy estate.  Derivative claims cannot be used by a single creditor to upset the structured bankruptcy process.  The Court dismissed Count II on the alternative ground that is failed to state a cognizable legal claim.  There are fundamental differences between this case and Production Resources, a decision which relied heavily on its unique facts.  As is clearly evident in Production Resources, all the challenged transactions occurred in the context of an already insolvent company.  In contrast, the amended complaint in this case only attempts to allege that HCC became insolvent after, and as a result of, the 2002 transaction.  The Plaintiff in this case had no right to repayment of its debt at the time of the challenged transaction.

Document: G. William Carlson, et al v. Charles Hallinan et al Del. Ch., C.A. No. 19808 and 19466 (March 21, 2006)

This direct and derivative action arises out of a dispute between two men engaged in the business of making short term, unsecured loans.  Plaintiffs had asserted against various defendants direct claims for breach of contract, derivative claims for breach of fiduciary duties and aiding and abetting said breach and claims for attorneys’ fees for a prior, related action and for this action.  Hallinan breached the oral contract with plaintiffs, Hallinan and Gordon committed multiple breaches of their fiduciary duties to CR, certain corporate defendants aided and abetted certain of those breaches of fiduciary duty, Plaintiffs are entitled to their attorneys’ fees for the Section 220 action and for the derivative claims on which they prevailed in this action.  The Court hold that CR should be dissolved and a receiver appointed to wind up its affairs.  Hallinan and Gordon bore the burden of establishing the entire fairness of their salaries and the management fee.  Director Defendants argue that because they, as a majority of the CR stockholders ratified the challenged transactions, the burden shifts to Plaintiffs to prove that the transactions were not entirely fair.  To have any effect, stockholder ratification must be by a majority of the disinterested and fully informed stockholders.  Here, the shares voting to ratify Hallinan and Gordon’s actions were held by Hallinan and Gordon themselves.  Hallinan and Gordon failed to show that any of the decisions to themselves executive compensation were the product of fair dealing.  Director Defendants provided no credible testimony that their compensation was appropriate in light of CR’s economic and financial circumstances.  The Court thus concludes that Hallinan and Gordon failed to satisfy the requirement of entire fairness to CR and therefore breached their fiduciary duties to CR by paying themselves the executive compensation they did.  Director Defendants failed to meet their burden that the price was entirely fair to CR.  Hallinan and Gordon’s utter failure to demonstrate that the management fee was the result of a fair process causes the Court to conclude that the management fee was not entirely fair to CR.  The Court found that Hallinan and Gordon never even considered an undertaking and made no decision to accept an implicit one.  The presumptions and protection of the business judgment rule cannot attach to such a nondecision.  Further, such a nondecision cannot satisfy the requirements of Section 145.  Therefore, the Court concluded that CR’s payment of Hallinan and Gordon’s expenses for the defense of this action was ultra vires.  Main Street and TC are liable to CR for aiding and abetting certain of the Director Defendants’ breaches of fiduciary duties.  The facts and circumstances here, however, comprise the very rare case where the appointment of a receiver and the dissolution of a solvent corporation is necessary.  Hallinan and Gordon have repeatedly breached their fiduciary duties in a continuing effort to enrich themselves at the corporation’s and Plaintiff Contact’s expense.  Without the appointment of a receiver to wind up CR’s affairs, the Court concludes that Hallinan and Gordon will continue to breach the duties they owe CR and thus cause further harm to the corporation and Plaintiffs.  The Court ordered to appointment of a receiver for CR.  Before dissolution, Hallinan shall repay to CR his and Gordon’s salaries as damages for breach of the oral agreement to form CR.  No further relief for the breach of fiduciary duties by Hallinan and Gordon with respect to their compensation is necessary.  Hallinan, Gordon and TC are jointly and severally liable for breach of fiduciary duties for CR’s payment of a management fee to TC and shall repay to CR all money paid as a management fee.  Hallinan and Gordon shall also repay to CR all money advanced to them for the defense of this action as remedy for CR’s void act.  Thus, if Carlson or Contact had a clearly established right to inspect CR’s books and records and Plaintiffs have shown by clear evidence that Hallinan or Gordon acted in subjective bad faith in refusing Plaintiff’s inspection demand, then the culpable Director Defendant will be liable to Plaintiffs for their attorneys’ fees in the Section 220 action.  Plaintiffs have made the requisite showing.  Hallinan and Gordon’s attempt to remove Carlson as a director of CR two days after he formally requested documents from CR pursuant to Section 220 amounts to a bad faith attempt to deny Carlson something to which he clearly was entitled.  The Court6 therefore concluded that the Director Defendants were liable to Plaintiffs for their reasonable attorneys’ fees for the Section 220 action.

Document: Highland Legacy Limited v. Steven G. Singer, et al. and Motient Corporation Del. Ch., C.A. No. 1566-N (March 17, 2006)

A large stockholder brought this derivative action alleging that the directors committed corporate waste by paying exorbitant fees and warrants over a period of years to two financial advisory firms for their services.  In addition, the plaintiff stockholder alleges an unrelated claim that the directors breached their fiduciary duties by allowing the brother of one of them to act in a managerial position in violation of a federal court order that forbids him from acting as an officer or director of any public company.  The defendants have moved to dismiss the complaint under Rule 23.1 for failure to allege with particularity facts establishing demand futility.  The Court dismissed the claims for failing to comply with Rule 23.1 to establish demand futility.  There were no well-pleaded allegations which allow the court to reasonably infer that Goldsmith and Steele were in any way controlled by or financially beholden to Singer.  The Plaintiff simply makes conclusory allegations that Goldsmith and Steele are dominated by Singer because they served together on a few boards of unaffiliated companies.

Document: Horbal, et al. v. Three Rivers Holdings, Inc., et al. Del. Ch., C.A. No. 1273-N (March 10, 2006)

The complaint alleges that these co-investors then abused their positions by siphoning off tens of millions of dollars from the HMO in the form of disguised salaries, bonuses and corporate perquisites or, as the plaintiffs prefer to them, “de facto dividends”.  Plaintiffs alleged breaches of the defendants’ fiduciary duties.  Plaintiffs also alleged they were improperly denied their right to a Section 220 inspection.  Plaintiffs’ de facto dividend claim centers on allegations of director self-dealing.  Plaintiffs alleged the director defendants used wholly-owned subsidiaries under their control to siphon off millions of dollars in the form of excessive salaries, bonuses and corporate perquisites.  Plaintiffs ask the Court to treat this excessive compensation as constructive or “de facto” dividends to which plaintiffs, as shareholders, have a right to share in equally.  With their de facto dividends theory, plaintiffs attempted to apply to corporate law a concept borrowed from tax law.  No Delaware Court has ever recast executive compensation as a constructive dividend.  Plaintiffs’ claim in this case implicated a classic allegation of self-dealing or waste.  Because plaintiffs had not adequately pled a duty of loyalty claim, the Court dismissed, without prejudice, plaintiffs’ purported claim for breach of fiduciary duty.  With respect to plaintiffs’ de facto dividends claim, the Court dismissed such claim with prejudice.  Plaintiffs were improperly denied their right to a Section 220 inspection of TR Holdings’ books and records.

Document: Canadian Commercial Workers Industry Pension Plan v. Eric Alden, et al. and Case Financial, Inc. Del. Ch., C.A. No. 1184-N (February 22, 2006)

Derivative action by ____ of Case Financial against former directors of Case Financial.  Plaintiff asserted claims for breach of loyalty and corporate waste, breach of duty of oversight (a Caremark claim) and common law fraud.  One of the directors (“Alden”) had previously entered into a release agreement with the company which released him except for conduct constituting a crime under California or federal law (“Crime Exception”).  Both directors moved to dismiss with respect to Alden, the Court rejected the motion as to the fraud and loyalty claims based on the Crime Exception, but dismissed claims as to breach of the duty of oversight based on the release.  The Court also found that Plaintiff failed to state a Caremark claim and so dismissed such claim as to the other director (“Bibicoff”).  Bibicoff’s motion to dismiss the fraud claim for lack of personal jurisdiction, as well as the two directors’ motion to dismiss based on an inadequate derivative plaintiff and improper delegation arguments is dismissed.

Document: Abry Partners V, L.P. v. F&W Acquisitions LLC, C.A. No. 1756 (February 14, 2006)

Buyer in the sale of a corporation sought to rescind the Stock Purchase Agreement (“SPA”) based on false statements contained within the agreement.  The seller moved to dismiss, for failure to state a claim, based on a provision in the SPA that limited the seller’s liability for misstatements to the content of a fund established to pay such damages.  The Court held that, to the extent that there was no intentional deception on the part of the seller, the buyer’s damages were restricted to the damages fund.  Intentional “lies” by the seller, however, would be not be protected by contract.

The Court rejected the view of the Restatement (Second) of Contract § 195, that reckless misrepresentation should not be protected by contract.

Document: Douzinas v. ABS Nautical Systems, LLC, C.A. No. 1496 (January 24, 2006)

Members of a manager-managed LLC alleged that the manager, inter alia, breached its fiduciary duties.  The Defendants argued that the claims must be arbitrated under the LLC Agreement.   The Plaintiffs responded that under Parfi Holding AB v. Mirror Image Internet, Inc., the claims should be allowed to proceed in the Court. The Court held that the Defendants were entitled to an order compelling arbitration.

The Parfi Holding case was distinguished by Elf Atochem North America, Inc. v. Jaffari, which stated that an arbitration clause in an LLC agreement could control fiduciary duty claims.
The Parfi Holding case was distinguished because, although corporate fiduciary duties cannot be altered by contract, the Delaware Limited Liability Act specifically allows fiduciary duties to be expanded, restricted or eliminated.
The Court interpreted the arbitration clause broadly, despite the distinction that the Elf Atochem arbitration clause specifically included the manager of that LLC, and the clause here did not, because the clause at issue covered “any dispute related to” the LLC Agreement.
The Plaintiffs were equitably estopped from bringing claims against affiliates of the LLC, who were not signatories to the LLC Agreement, outside of arbitration, because the affiliate claims were interconnected with the claims that will be arbitrated for other defendants.  To allow those claims to proceed would defeat much of the purpose of the arbitration clause.

Document: Delucca v. KKAT Management, LLC, C.A. No. 1384 (January 23, 2006)

A manager of an LLC, in a group of LLCs operating as structured investment funds, sought advancement of legal fees to defend an action her former employer brought against her for breach of fiduciary duties.  The defendant companies responded that the action against the manager did not implicate the advancement provision.  The Court granted the plaintiff relief on both the claims for advancement and fees-on-fees.

Defendants argued that the manager had primarily harmed the LLC that employed her, rather than the group of LLCs as a whole, so the indemnification provision was not implicated.  The Court found this distinction unconvincing, and contrary to the plain language of the indemnification provision.
The Court distinguished indemnification provisions in the corporate context under DGCL § 145, from contractual provisions in an LLC Agreement.  In the corporate context, a person is indemnified for liability due to acts made by reason of the fact that they were an officer, director, employee, or agent of the corporation.  This was narrower than the LLC Agreement, which provided advancement “in connection with or arising out of or related to” the LLC Agreement, or the operations or affairs of the group of LLCs.

The Court was not sympathetic to the argument that the allegedly treacherous acts by the manager should prevent advancement – this was “precisely  …  the circumstance [where] advancement is critical.”