Delaware Transactional Law Updates

In re Solera Holdings, Inc. Stockholder Litigation

The Delaware Court of Chancery dismissed a complaint that alleged breach of fiduciary duty against directors that approved a merger. The Court concluded that the merger, which would generally have been subject to enhanced scrutiny review, was cleansed by the fully informed, uncoerced vote of the disinterested stockholders. As a result, the business judgment rule applied and, in order to move forward, the plaintiff was required to prove that the directors’ decision constituted waste.

BOTTOM LINE: The fully informed, uncoerced vote of a disinterested majority of shareholder will cleanse a challenged transaction that would generally be subject to enhanced scrutiny.

Sandys v. Pincus, et al.

The Delaware Supreme Court reversed a Delaware Court of Chancery decision that dismissed a derivative complaint based on the plaintiff-shareholder’s failure to make a pre-suit demand on the Company’s board of directors. The Court of Chancery had determined that because the majority of the board was independent, the plaintiff-shareholder was required to make a demand on the Board to file suit on behalf of the Company. On appeal, the Delaware Supreme Court disagreed and found that the plaintiff-shareholder had shown that the majority of the board of directors was conflicted and thus a pre-suit demand was not necessary. The Court’s decision was based on several different conflicts amongst three board members, including the co-ownership of an airplane between one director and the controlling stockholder of the company, and two other directors’ “interlocking” financial ventures and relationships with the controlling shareholder. Notably, the Court admonished the plaintiff for failing to direct a books and records request to the Company on issues bearing on the board members’ independence, finding that “the plaintiff‘s lack of diligence put the Court of Chancery in a compromised and unfair position to make an important determination regarding these directors’ pleading stage independence.”

BOTTOM LINE: Delaware courts will review the independence of directors in as detailed a fashion as they review the independence of financial advisors. As a result, plaintiffs must be extremely diligent in their review of a board’s independence before determining that a pre-suit demand on the board is unnecessary.

IAC Search, LLC v. Conversant LLC

The Delaware Court of Chancery addressed a claim of fraud in connection with the purchase of six subsidiary companies of ValueClick, Inc. made pursuant to a Purchase Agreement. The plaintiff-buyer alleged that ValueClick, Inc. fraudulently induced it to overpay for one of the subsidiaries. The Court found that this claim was foreclosed based on the combination of an affirmative anti-reliance clause and an integration clause found in the Purchase Agreement. The anti-reliance clause stated: “The Buyer acknowledges that neither the Seller nor any of its Affiliates or Representatives is making, directly or indirectly, any representation or warranty with respect to any [purchase-related information], unless any such information is contained in [this Agreement].” The Purchase Agreement’s integration clause set forth standard integration language that clearly defined the writings that comprised the parties’ agreement.

BOTTOM LINE: In order to foreclose claims of fraud based on statements or omissions made outside the terms of a contract, the contract must contain an affirmative disclaimer that either: (1) specifically includes what the party claiming fraud is relying upon when it decides to enter into the agreement or (2) that the party claiming fraud was not relying on any representations made outside of the agreement.

If your deal documents do not properly establish which document trumps another, the unintended results may be very costly.

In this connection, please see a new Delaware Supreme Court opinion by clicking here.

It is a reminder to take extra care with your subscription documents, side letters, LLC agreements, partnership agreements and series provisions, just to name a few.

Abelmann v. Granum, et al.

The Delaware Court of Chancery addressed a petition for judicial dissolution of a Delaware limited liability company (the “Company”). The court began its analysis by noting that judicial dissolution of an LLC is granted sparingly and is only proper when “it is not reasonably practicable to carry on the business in conformity with a limited liability company agreement.” Both the petitioner and the respondents agreed that the Company was deadlocked and needed to be dissolved. However, the respondents did not want the dissolution of the Company to negatively affect their position in a separate action being litigated in California. To resolve this problem, the Court issued an order that dissolved the Company but mandated that the dissolution not foreclose or affect the respondents’ standing in the separate California Action.

BOTTOM LINE: You can avoid deadlock between the members of an LLC by carefully drafting the operating agreement to account for such a situation. A sound operating agreement will provide the process that must be used to resolve a deadlock. For example, the operating agreement could include a dispute resolution clause, which requires the parties that are deadlocked to submit the issue to a neutral third party for resolution.

NOTE: This is an interesting case in that it involves a Delaware Court ordering a party not to use a specific defense in an out-of-state action as a condition to judicial dissolution. As such, it involves principles of equity under Delaware law as well as principles of choice of law. If appealed, this case should be closely observed to see how the Delaware Supreme Court addresses the interplay between both sources of law.

Finger Lakes Capital Partners, LLC v. Honeoye Lake Acquisition, LLC, et al.

The Delaware Supreme Court was asked to review a Court of Chancery decision that determined the profits of a successful investment entity would be distributed in accordance with the dictates of an LLC Agreement only. Ancillary documents, including a term sheet and clawback agreement, would not be considered. The Court determined that such ancillary documents were secondary agreements, which applied only to reallocate the distributions made pursuant to the LLC operating agreement.

BOTTOM LINE: If transaction documents do not properly establish a hierarchy of authority among them, unintended consequences may result. As a result, when entering an investment venture, it is vital to understand the intertwining relationship among transaction documents.

In Re Books-A-Million, Inc. Stockholders Litigation, C.A. No. 11343-VCL (Del. Ch. Oct. 10, 2016)

The Court of Chancery addressed a claim for breach of fiduciary duty in connection with a going-private transaction that utilized the deal protections set forth by the Delaware Supreme Court in Kahn v. M&F Worldwide, Corp. The Court reiterated that the proper use of the Kahn protections makes it nearly impossible for minority shareholders to successfully claim breach of fiduciary duty against controlling shareholders or board members in a going-private transaction.  The plaintiff’s only options are to successfully allege that the Kahn protections were not satisfied or that the transaction at issue constituted waste under Delaware law.

BOTTOM LINE: The business judgment rule will apply, and all but foreclose successful claims of breach of fiduciary duty, when  (i) a transaction is conditioned on the approval of both an independent Special Committee of the Board and an informed majority of the minority stockholder vote; (ii) the Special Committee is empowered freely to select its own advisors and to say no definitively; (iii) the Special Committee meets its duty of care in negotiating fair price; and (iv) there is no coercion of the minority shareholders.

Jay Fretcher v. Cryo-Cell International, Inc., C.A. No. 11915-VCG (Del. Ch. Oct. 07, 2016)

The plaintiff-stockholder sued the defendant-corporation seeking a declaration that a provision in a corporation’s bylaws was illegal.  The provision at issue provided that directors could be removed by shareholders “for cause.”  However, pursuant to Section 141(k) of the Delaware General Corporation law, stockholders may remove directors “with or without cause.” After the plaintiff filed for summary judgment, the defendant-corporation amended its bylaws to remove the relevant language, which mooted the action.  In addressing the proper fee award in the mootness proceeding, the Court recognized that the bylaw provision at issue was not explicitly illegal, but was misleading to stockholders and could have a chilling effect on the exercise of their franchise under Section 141.

BOTTOM LINE: Shareholders have an absolute right to remove directors with or without cause.  A bylaw provision that speaks only to removal of directors “with cause,” without mentioning the removal of directors “without cause,” is misleading and potentially illegal.  A bylaw setting forth the process a shareholder may use to remove directors must be drafted to make clear that “cause” is not a requisite for such removal.

The Huff Energy Fund, L.P. v. Gershen, C.A. No. 11116-VCS (Del. Ch. Sep. 29, 2016)

The Delaware Court of Chancery was asked to determine whether directors of a Delaware corporation (the “Corporation”) could be found to have individually breached a Shareholders Agreement (the “Agreement”) between the Corporation and its largest shareholder (the “Shareholder”) based on the directors’ signing the Agreement.  The Court ruled that it was “clear from the face of the [Agreement]” that the directors did not sign the Agreement in their individual capacity, but rather signed the Agreement on behalf of the Corporation.  As such, they were not party to the Agreement under Delaware law and could not be found to have breached its terms.  

The Court also addressed a claim that the Corporation breached the Agreement by adopting a Plan of Dissolution to dissolve the Corporation.  The plaintiffs argued that the Plan of Dissolution violated, among other provisions, a clause that stated that the Corporation “shall continue to exist and shall remain in good standing under the laws of its state of incorporation and under the laws of any state in which [it] conducts business.”  The Court disagreed, stating: the clause “appears to be nothing more than a recognition by [the Corporation] that it will remain in good standing as a Delaware corporation.  It speaks to a commitment to make necessary filings and pay required fees and expenses. It is a stretch to read more into the provision, particularly the commitment to exist ‘come what may’ that [the plaintiff] ascribes to it.”

BOTTOM LINE: If you wish a contract to be enforceable against a certain party, that party must sign the contract in its individual capacity.  The fact that the individual has signed as a representative of another is simply not sufficient.  Additionally, a standard representation that a corporation will remain in existence in good standing is not a prohibition of its dissolution or cancellation.  In order to ensure such a restriction, specific representations must be carefully drafted and included in the relevant document.

Grand Acquisition, LLC v. Passco Indian Springs DST, C.A. No. 12003-VCMR (Del. Ch. August 26, 2016) (Revised: September 7, 2016)

The Delaware Court of Chancery was asked to determine whether the beneficial owner (the “LLC”) of a statutory trust (the “Trust”) had the right to inspect the books and records of the trust. The answer depended upon whether the Trust Agreement of the Trust incorporated the terms of 12 Del. C. § 3819, which authorizes restriction to access under certain circumstances. The Court determined that the Trust Agreement did not incorporate the restrictions permissible under § 3819, and, as a result, access could not be restricted. In so doing, the Court relied upon judicial precedent holding that a contractual books and records right in a limited liability company or limited partnership is independent of the relevant statutory right.

BOTTOM LINE: Like Delaware LLCs and LPs, Delaware statutory trusts may create rights under their Trust Agreements separate and apart from their statutory rights. In such instances, the relevant statutory rights will be inapplicable, assuming the Delaware Statutory Trust Act permits modification.

City of Miami General Employees’ and Sanitation Employees’ Retirement Trust v. Comstock, C.A. No. 9980-CB (Del. Ch. August 24, 2016)

The Court of Chancery applied the business judgment rule to dismiss the plaintiff’s post-closing monetary damages claims in connection with a challenged merger that was approved by a majority of disinterested, informed, and uncoerced shareholders. The Court stated: “[P]laintiff’s claims for post-closing damages against [defendant] directors and officers are subject to the business judgment presumption under the Delaware Supreme Court’s decision in Corwin v. KKR Financial Holdings LLC because of the legal effect of the stockholder vote, and that judicial review of plaintiff’s fiduciary duty claims (and related aiding and abetting claims) thus ends there.”

The Court of Chancery analyzed and refined the same principle in a separate opinion published one day after the court’s decision in the case above. In Larkin v. Shah, former shareholders of Auspex Pharmaceuticals, Inc. filed suit for post-closing monetary damages in connection with the 2015 acquisition of Auspex (the “Merger”), which was approved by a majority of Auspex’s disinterested shareholders. The plaintiffs alleged that the directors of Auspex breached their fiduciary duties by entering into the first all-cash deal they could land without regard for other superior offers. They contended that the Corwin decision, which held that the business judgment rule applies to “a transaction not subject to the entire fairness standard, that is approved by a fully informed, uncoerced vote of the disinterested stockholders,” did not apply to any transactions which are subject to entire fairness. The Court disagreed and found that the only transactions subject to entire fairness that cannot be cleansed by proper stockholder approval are those involving a conflicted controller. The Court concluded that because the Merger did not involve a conflicted controller, the Corwin decision applied and the business judgment rule was the appropriate standard of review.

BOTTOM LINE: The business judgment standard applies to transactions subject to enhanced scrutiny if a majority of disinterested, uncoerced stockholders approve the transaction unless the challenged transaction involves a conflicted controller. This application of the rule may not be rebutted. Therefore, if a Board of Directors discloses all information related to the conflict to minority shareholders and they approve the transaction anyway, the plaintiff-shareholders seeking relief must overcome the steep burden of the business judgment rule. The only practical way the plaintiffs will be able to accomplish this is by pleading facts showing the stockholder vote was not informed, was coerced, or that a conflicted controller was in fact at issue.

James Pogue v. Hybrid Energy, Inc., C.A. No. 11563-VCG (Del. Ch. August 5, 2016)

The Court of Chancery addressed an alleged shareholder’s claim to inspect the books and records of the defendant entity, Hybrid Energy, Inc. (“Hybrid”). The plaintiff claimed that Hybrid had issued him a stock certificate evidencing ownership of 1 million shares of Hybrid common stock. The plaintiff was also listed as a shareholder on Hybrid’s corporate stock ledger. However, at the time the plaintiff’s alleged stock certificate was issued, Hybrid’s Certificate of Incorporation authorized only 1,500 shares of common stock, all of which were already issued to someone other than the plaintiff. Nevertheless, the Court determined that the plaintiff’s name appearing on Hybrid’s share ledger was enough to create a rebuttable presumption that he was a shareholder entitled to inspect the books and records of Hybrid. The Court went on to find, however, that Hybrid had put forth enough evidence to rebut the presumption and the plaintiff was not entitled to access the books and records.

BOTTOM LINE: This case serves as a reminder that Delaware corporations must keep an accurate stock ledger and books and records in order to avoid numerous potential issues. The appearance of a name on a corporation’s stock ledger will create a presumption, only rebuttable by other evidence to the contrary, that the person so named is a shareholder of the company.

Aleynikov v. The Goldman Sachs Group, Inc., C.A. No. 10636-VCL (Del. Ch. July 13, 2016) POST-TRIAL ORDER AND FINAL JUDGEMENT

The Court of Chancery analyzed a claim for advancement made by a former computer programmer (“Aleynikov”) of Goldman, Sachs & Co., a subsidiary of The Goldman Sachs Group, Inc. (“Goldman Parent”). Despite not having any managerial or supervisory responsibilities, Aleynikov held the title of “Vice President.” He argued that he was entitled to advancement pursuant to the bylaws of Goldman Parent, which provided for advancement and indemnification to the “fullest extent permitted by law” to all directors and officers of any subsidiary of Goldman Parent. The bylaws defied “officers” of Goldman Parent subsidiaries to include “in addition to any officer of such entity, any person serving in a similar capacity or as manager of such entity.”

The Court analyzed the definition of the term “officers” in the context of the Goldman Parent’s bylaws and the Delaware General Corporation Law and concluded that Aleynikov should be considered an officer. The Court noted that “Goldman Parent and its subsidiaries created ambiguity about the scope of the officer designation by handing out the title ‘Vice President’ freely to their employees.”

BOTTOM LINE: An ambiguity in the unilaterally drafted organizational documents of a parent company will be construed against the Parent company. In order to protect itself from ambiguity and unintended liability, a parent company’s organizational documents that govern subsidiaries must align clearly with the policies and governance of those subsidiaries.

The Williams Companies, Inc. v. Energy Transfer Equity, L.P., C.A. No. 12337-VCG & C.A. No. 12168-VCG (Del. Ch. June 24, 2016)

The Court of Chancery addressed the terms of a Merger Agreement executed in September 2015. Pursuant to the Merger Agreement, Energy Transfer Equity, L.P. (“ETE”), a Delaware limited partnership, would acquire The Williams Company, a Delaware corporation (“Williams”). Both ETE and Williams are substantial participants in the gas pipeline business.

As a condition precedent to the merger, Latham & Watkins LLP, counsel to ETC (“Latham”) was required to deliver a legal opinion to both parties to the effect that specific transactions within the merger agreement “should” be treated as a tax-free exchange under Section 721(a) of the Internal Revenue Code (the “721 Opinion”). The merger agreement required that ETC use “commercially reasonable efforts” to obtain the 721 Opinion, but failed to define the phrase “commercially reasonable efforts.”

In March 2016, after a significant decline in the energy market and the value of assets being transferred by Williams in the merger, Latham realized that it could not issue the 721 Opinion for tax-based reasons. In April 2016, Williams filed suit against ETC alleging that it had failed to use commercially reasonable efforts to obtain the 721 Opinion.

Although Latham was not named as a defendant, the Court began its analysis by ruling that Latham acted in good faith, noting that Latham devoted over 1000 attorney hours to determining whether the 721 Opinion could be delivered. Next, the Court determined that ETE’s efforts to obtain the 721 Opinion were commercially reasonable because they were “objectively reasonable” and there were no actions that ETC could have taken to make Latham issue the 721 Opinion.

BOTTOM LINE: The importance of choosing diligent and experienced counsel to issue closing opinions cannot be overstated. If the counsel requested to provide the opinion fails to exercise due diligence and determine in good faith whether it can or cannot provide the opinion post-execution of a merger agreement, the counsel’s client may be liable for failing to exercise “commercially reasonable efforts” to obtain the opinion.

In Re Chelsea Therapeutics International Ltd. Stockholders Litigation, Consol. C.A. No. 9640-VCG (Del. Ch. May 20, 2016)

The Court of Chancery addressed a class action suit which alleged a breach of the duty of loyalty by several independent, disinterested members of the Board of Chelsea Therapeutic International, Ltd. (“Chelsea”).  The stockholders claimed the defendants acted in bad faith by knowingly selling Chelsea significantly below its standalone value, ignoring more favorable financial projections for the company, and instructing Chelsea’s financial advisors to ignore certain financial projections.

The Court of Chancery, noting that the application of bad-faith analysis was a “hazy jurisprudence,” rejected the plaintiffs’ arguments.  The Court found that the plaintiffs had failed to state a bad faith claim, which requires “an extreme set of facts to establish that disinterested directors were intentionally disregarding their duties, or that the decision under attack was so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.”  The Court reasoned that the projections ignored by the defendants were “highly speculative” and the defendants’ choice to ignore them was not “without the bounds of reason.”

Employees Retirement System of the City of St. Louis v. TC Pipelines GP, Inc., et al C.A. No. 11603-VCG (Del. Ch. May 11, 2016)

A limited partner (the “LP”) in a Delaware limited partnership (the “Company”) filed suit against the general partner (the “GP”) of the Company for breach of the Company’s Limited Partnership Agreement (the “LP Agreement”). The LP claimed that the GP failed to ensure that a conflicted transaction between the Company and the GP’s parent company was “fair and reasonable” as was required by the LP Agreement.

The Court of Chancery rejected the LP’s claim. The Court reasoned that the conflicted transaction was cleansed by the approval of a special committee under the terms of the LP Agreement, which stated:

“Any conflict of interest and any resolution of such conflict of interest shall be conclusively deemed fair and reasonable to the Partnership if such conflict of interest or resolution is (i) approved by Special Approval (as long as the material facts known to the General Partner or any of its Affiliates regarding any proposed transaction were disclosed to the Conflicts Committee at the time it gave its approval) . . . .”

BOTTOM LINE: In the alternative entity context, you must only agree to terms by which you are willing to be bound and you should always consult counsel as to the advisability and fairness of all terms. Delaware courts will enforce the terms of an alternative entity’s constitutional documents whether or not they are objectively fair.

On May 2, 2016, Governor Jack Markell declared his support for the Delaware Blockchain Initiative (the “Blockchain Initiative”) which would allow Delaware corporations to issue corporate shares using the same technology that powers the online currency Bitcoin.  By creating a single digital ledger of transactions that is shared among a network of computers, the hope is that blockchain technology will simplify the process of issuing shares of stock.

Currently, financial institutions’ databases are isolated from one another.  In order to update one database, the assistance or approval of another financial institution is often required. In contrast, each participant that uses the blockchain technology will maintain a complete copy of a single ledger. In accordance with the terms of a consensus protocol system, participants will act collectively to validate and record transactions in the single ledger.  As a result, given no intermediaries are necessary, the costs and timing associated with them are eliminated.

Bottom Line: Although a novel and potentially beneficial tool, the General Corporation Law of the State of Delaware (“DGCL”) does not permit the authorization of blockchain-based shares.  The members of the Blockchain Initiative will have to work closely with the Delaware Corporation Law Council, of which Ellisa Habbart is a member, to consider and develop amendments to the DGCL permitting the issuance of such shares.

Document: Obeid v. Hogan, C.A. No. 11900-VCL (Del. Ch. Apr. 27, 2016)

The Court of Chancery examined the operating agreements of two Delaware limited liability companies (“LLCs”) to determine whether a third party could serve as the sole member of a special litigation committee in each LLC.

One of the two LLCs adopted a governance structure mimicking that of a corporation and using language drawn directly from the corporate domain.  It established a manager-managed governance structure that empowered a “Corporate Board” to act as the sole manager.  The “Corporate Board” was authorized to designate committees of “one or more of the Directors of the Company.”  The Court ruled that such language required the Court to apply corporate precedents, including the prohibition against non-directors acting on a special litigation committee.

The second LLC established a similar management structure. Its LLC Agreement provided that “the powers of the Company shall be exercised by or under the authority, and the business and affairs of the Company shall be managed by, one or more Managers.”  The Court determined that provisions of the LLC, taken as a whole, addressed the issue by expressly limiting the power of the managers to delegate their core governance functions.  As a result, only managers could serve on a special litigation committee.

Bottom Line: If the parties to an LLC wish to avoid the consequences of corporate precedents, do not include language typically associated with a corporation in an LLC Agreement.  In addition, the LLC Agreement should include provisions that address if and how delegation is permitted. 

 Wong v. USES Holding Corp., C.A. No. 11475 (Del. Ch. Apr. 5, 2016)

The Court of Chancery was asked to determine whether a former director and former officer were entitled to recover all fees they incurred to contest their former corporation’s refusal to provide advancement. This is commonly known as “fees on fees.” The bylaws of the corporation provided:

[I]f the Delaware Statute requires, an advancement of expenses incurred by an indemnitee in his or her capacity as a director or officer . . . shall be made only upon delivery to the Corporation of an undertaking . . . by or on behalf of such indemnitee, to repay all amounts so advanced if it shall ultimately be determined by final judicial decision . . . that such indemnitee is not entitled to be indemnified . . . .

The corporation argued that plaintiffs filed suit for advancement prematurely.  The bylaws provided the corporation with 60 days to respond to a request for fees on fees and the suit was filed only 35 days after the request for indemnification was delivered. The court disagreed and interpreted the bylaw to mean that the corporation had 60 days to consider a request for advancement.  However, since the corporation had rejected the claim for advancement before the end of the 60-day period, there was no need for the plaintiffs to wait 60 days for their rights to accrue.

BOTTOM LINE: “Fees on Fees” begin to accrue on the date the director or officer complies with the undertakings required in the corporation’s bylaws and the DCGL. Care must be taken to precisely set forth the conditions that must be fulfilled by the indemnitee.

Dieckman v. Regency GP LP, C.A. No. 11130 (Del. Ch. Mar. 29, 2016)

The Court of Chancery analyzed a limited partnership agreement that eliminated all fiduciary duties but included a contractual governance structure. The governance structure contained a number of safe harbors that, if satisfied, “cleansed” potentially conflicted transactions. A former unit holder of the limited partnership (the “LP”) claimed that the General Partner of the LP violated the “good faith” contractual standard set forth in the LP agreement by favoring the interests of its affiliates in a unit-for-unit merger (the “Merger”).

The LP Agreement mandated that “whenever the General Partner makes a determination or takes any action, it must do so in good faith.”  One of the safe harbors available cleansed a potentially conflicted transaction if it was “approved by the vote of a majority of the [unaffiliated] Common Units . . . .”

Although a majority of unaffiliated common units approved the Merger, the former unitholder argued the safe harbor did not apply because the unitholders were not fully informed about the transaction. The Court disagreed and determined it would be “inappropriate to reinsert the duty of disclosure or any other common law disclosure requirements into the unitholder approval safe harbor” based on the following language of the LP Agreement:

Except as expressly set forth in this Agreement, neither the General Partner nor any other Indemnitee shall have any duties or liabilities, including fiduciary duties, to the Partnership or any Limited Partner and the provisions of this Agreement, to the extent that they restrict, eliminate or otherwise modify the duties and liabilities, including fiduciary duties, of the General Partner or any other Indemnitee otherwise existing at law or in equity, are agreed by the Partners to replace such other duties and liabilities of the General Partner or such other Indemnitee.