If a corporation wants to curtail the power of directors to fill board vacancies, it cannot rely on 8 Del C. § 223(c), but must state the limitation in its certificate or bylaws
In the first case before the Court of Chancery turning on application of 8 Del. C. § 223(c), Vice Chancellor Sam Glasscock, III, rejected the stockholder plaintiffs’ contention that the statute created a presumption in favor of a new election, holding instead that stockholders must prove the equities weigh in their favor to prevail in a Section 223(c) action.
Two months after five directors were elected to L.O.M’s board, two of them resigned, followed shortly by a third. This left only two directors, who then executed written consents appointing a third director. By July 2013, the three directors had appointed two more men to fill the remaining vacancies. In addition to the presumption argument noted above, the plaintiffs argued that a new election was necessary because the appointed directors had authorized a private placement that favored one faction of stockholders over another.
The Court held that Section 223(c) provided only a limited exception to directors’ authority to fill board vacancies, given the caveat in the statute that “directors may fill board vacancies only where doing so is not prohibited by a company’s certificate of incorporation or bylaws. Because a company has the ability to entirely eliminate the authority granted to directors under 223(a), the utility of 223(c) to constrain directorial authority is minimal; Section 223(c) merely creates a narrow avenue whereby the Court may prevent directors from filling board vacancies where doing so is necessary to avoid some identifiable inequity.” Plaintiffs bear the burden of demonstrating this inequity, and the allegations in this case regarding the private placement were not enough to outweigh the fact that the company lacked the necessary funds to hold another stockholder meeting and election, the Court said.
Drafting errors can be compounded by using an earlier agreement as a model in similar deals
After plaintiffs prevailed in litigation arising from drafting errors, they sought to have attorneys’ fees shifted. The errors involved incentive clauses in joint venture agreements known as “promotes.” An associate at DLA Piper, representing ASB, placed a tier of promote in the wrong place in the agreement, which “altered the business terms of the joint venture because Scion would begin to earn its promote immediately after the project satisfied its first preferred return amount but before the parties recovered their initial capital investment,” said the opinion, written by Vice Chancellor J. Travis Laster. Scion’s principal noticed the mistake but said nothing, neither the law firm nor ASB caught the error, and the mistake was repeated in other agreements. This resulted in a 282 percent gain for Scion on a deal where ASB lost 30 percent. Without the drafting error, the parties would have shared the loss proportionately. Not surprisingly, ASB reexamined the agreements and sought reformation. Scion preemptively sued in three different jurisdictions connected to different deals – despite being aware of the unilateral mistake. ASB sued in Delaware, won reformation, and sought fee shifting.
The Chancery Court initially awarded fees to ASB but the Delaware Supreme Court reversed, holding that there was no basis for contractual fee-shifting because DLA Piper handled the case at no cost to ASB. The case was remanded for consideration of whether an equitable basis existed for fee shifting. While the Chancery Court did not aware any fees for pre-litigation conduct – stating that such an award would reward DLA Piper for its mistake – the Court did find bad faith in Scion’s litigation strategy, described as designed to ”drive up litigation costs and extract a favorable settlement disproportionate to the merits.” The Court found this award equitable because it “does not risk compensating DLA Piper for its own mistakes in preparing the Disputed Agreements. It rather compensates DLA Piper for the additional, incremental cost of confronting bad faith tactics that the firm should not have to absorb.”
Shareholders’ derivative claims will survive a merger that extinguishes their ownership only if the merger’s sole purpose was to extinguish the derivative claims
The U.S. 9th Circuit Court of Appeals certified a question to the Delaware Supreme Court on the whether the fraud exception to Delaware’s continuous ownership rule allows shareholder plaintiffs to maintain a derivative suit, even after a merger divested them of their ownership interest, by alleging that the merger at issue was forced by the alleged fraud. The Court answered in the negative, explaining that its dictum in Arkansas Teacher Retirement Systems v. Caiafa (Del. 2010) dealing with the fraud exception pertained only to direct claims. The Caiafa suit involved direct claims challenging Countrywide’s merger with Bank of America. When the case settled, certain plaintiffs – the same as those in the federal Countrywide case – objected to the settlement. The Court of Chancery approved the settlement, and the Supreme Court affirmed. However, in dictum the high court discussed a claim that the objectors failed to bring: that one long continuous fraud had so depressed the value of the company that a “fire sale” was a necessity. Armed with the dictum, the plaintiffs sought reconsideration of the case they had lost in federal court in California. The matter eventually reached to 9th Circuit, which then certified its question.
In answering, the Supreme Court explained that Caiafa had reiterated that shareholders may maintain suits post-merger if the merger itself is allegedly perpetrated merely to deprive shareholders of standing to bring a derivative action. The Countrywide deal was not such a merger, the Court said in an opinion written by Justice Randy J. Holland. Finally the Court stated that the dictum Caiafa pertained to direct claims for reduced consideration in a fire sale, and “did not ‘clarify,’ ‘expand,’ or constitute ‘a new material change’ in [the] continuous ownership rule or the fraud exception.” To the contrary, the Court unequivocally held that the Countrywide–Bank of America merger extinguished the plaintiffs’ derivative standing.
If more than one provision in an operating agreement addresses an issue, which provision controls, and/or how the provisions work together must be clearly stated
Document: Edmond Costantini, et al. v. Swiss Farm Stores Acquisition LLC, C. A. No. 8613–VCG (Del. Ch. September 5, 2013)
In this case, plaintiffs sought indemnification after Swiss Farm sued them for breach of fiduciary duty and lost the case based on laches. While Plaintiff Costantini was a manager of the limited liability company (“LLC”), Plaintiff Kahn was a merely partner in a partnership that was a member. As a result, the Court found that Costantini was entitled to indemnification, but Kahn was not. Swiss Farm argued that neither was entitled to indemnification. The LLC pointed to a provision in its operating agreement stating that any member or manager shall be indemnified only when he or she has met the good faith standard of conduct as set forth in the agreement. However, Swiss Farm had imported other indemnification provisions into its agreement from the Delaware General Corporation Law, including this provision: “To the extent that a present or former director or officer of a corporation has been successful on the merits or otherwise in defense of any action . . . such person shall be indemnified against expenses (including attorneys’ fees)[.]” 8 Del C. § 145(c). Swiss Farm argued that the “success on the merits or otherwise” clause was subject to the good faith standard of conduct, but Vice Chancellor Sam Glasscock, III, rejected this notion, stating that the language ‘on the merits or otherwise’ is meant to indicate that where a managing member prevails in any manner, she is entitled to indemnification.” On the other hand, Kahn, as neither a manager nor a member, “was simply not an indemnitee under the terms of the Operating Agreement.”
In determining whether a case should be dismissed based on the equitable doctrine of laches, Delaware courts will not use the statute of limitations to define unreasonable delay if unusual conditions or extraordinary circumstances are present
Document: Levey v. Brownstone Asset Management LP, No. 551, 2012 (Del. August 27, 2013)
The Delaware Supreme Court reversed the Court of Chancery, finding that, in the interest of justice, the doctrine of laches by analogy to the statute of limitations should not be applied. After voluntarily leaving Brownstone and two related entities, Levey was sued in federal court by his former partners. Levey counterclaimed for a return of capital and a cash payment. The matter went to arbitration, but the arbitrator disclaimed jurisdiction in June 2008. Levey did not file suit in the Court of Chancery until August 2010. Because of this delay, the Chancery Court dismissed the suit, determining that Levey knew he had a claim by January 2007, and that his delay was unreasonable by analogy to the three-year statute of limitations for contract claims. The Supreme Court reversed, finding that Levey’s delay was not unreasonable because he satisfied four of the five factors set out in IAC InterActiveCorp. v. O’Brien (Del. 2011) that signify the presence of unusual conditions or extraordinary circumstances. These factors included Levey’s timely pursuit of his claim through litigation and arbitration, the fact that the defendants had participated in the prior proceedings, and the existence of a bona fide dispute.
An unfair process will not cause a deal to fall short of the entire fairness standard as long as the price is adequate
Vice Chancellor Travis J. Laster found the 2005 sale of Trados Inc. entirely fair even though the directors’ failed to follow a fair process and the common stockholders were left out of the money. When a changing market caused Trados to have cash-flow problems despite consistent, if slow, growth, a group of directors with ties to the company’s venture-capital (“VC”) investors determined that the highest return would come through a sale. The VC investors held preferred stock with a liquidation preference that consumed the majority of the sale price. The small amount left went to cover a management incentive plan devised and adopted by the VC directors to ensure that Trados could be sold in the near term for a price that would offer some return on investment. The Court found that the neither VC directors nor the independent directors ever considered whether the alternative – continued operation of the company – would achieve value for the common stockholders. However, a credible and thorough valuation of Trados by the defendants’ expert witness revealed that the common stock had no value at the time of the merger, and poor prospects to achieve value. Therefore, the unfair process did not poison the entire transaction.
A party’s waiver of claims cannot be considered “success” for indemnification purposes before a final decision in the case
Document: Huff v. Longview Energy Co., C.A. No. 8453–CS (Del. Ch. August 12, 2013)
Chancellor Leo E. Strine, Jr., dismissed a complaint seeking indemnification because the claim was not yet ripe. Plaintiffs sought indemnification from Longview, a Delaware corporation that they serve as directors. A Texas court had entered judgment against plaintiffs for breach of fiduciary duty in connection with their usurpation of a corporate opportunity, and plaintiffs appealed. They then sought indemnification, contending they were “successful,” within the meaning of 8 Del. C. § 145(c), because Longview’s original eight counts in the Texas litigation had been whittled down to a single breach of fiduciary duty claim. Plaintiffs also asserted that Longview waived the ability to resurrect these counts because it did not file an appeal itself. The plaintiffs analogized to cases in which a corporate fiduciary sought indemnification because specific criminal counts were dismissed even though the fiduciary was found guilty on other charges. The chancellor rejected the analogy and granted Longview’s motion to dismiss, stating the argument that Longview has forever waived any right to press its other claims cannot be accepted without a final appellate decision by the Texas courts and a complete record.
The Court’s analysis highlights two important points that must be considered when preparing an LLC agreement: 1) if you want the payment of capital contributions to be tied to the percentage of ownership, you must specifically state this in the agreement; 2) your agreement should expressly modify fiduciary duties owed by the managing members — as permitted by the LLC Act — to avoid the application of corporate-like fiduciary duties.
Document: Grove v. Brown, C.A. No. 6793–VCG (Del. Ch. August 8, 2013)
In Grove, a dispute arose among the four members of a limited liability company (“LLC”), who split into two camps. Camp A effected a freeze-out merger based on its belief that it owned a majority interest in the LLC given that Camp B had failed to make its entire capital contribution. Vice Chancellor Sam Glasscock, III, held that Camp A did not own a greater-than-50-percent interest in the LLC because the operating agreement did not make ownership percentage dependent upon the receipt of the capital contribution. Camp A also alleged that Camp B breached its fiduciary duties by usurping a business opportunity belonging to the LLC. The vice chancellor held that Camp B breached its fiduciary duty of loyalty when it formed entities in Delaware and Maryland that competed directly with the LLC.
Chancery Court Upholds Validity of Forum Selection Bylaws
The Delaware Court of Chancery held that forum selection bylaws adopted unilaterally by boards of directors of Delaware corporations are not facially invalid if the corporation’s certification of incorporation authorizes the board of directors to amend the bylaws and the scope of the forum selection bylaws is limited to the regulation of stockholder suits in cases which would be governed by Delaware’s internal affairs doctrine. However, the Court held that the adoption of such forum selection bylaws might not be equitable in all circumstances and left open the possibility that the adoption of forum selection bylaws could be challenged by stockholders on fiduciary or reasonableness grounds.
Delaware Supreme Court Upholds Chancery Court Ruling on Forum Selection Clause
The Delaware Supreme Court affirmed the Delaware Court of Chancery’s decision in an anti-suit injunction action, in which Carlyle Investment Management LLC (“Carlyle”) sought to enjoin National Industries Group Holding, a Kuwaiti company (“NIG”), from litigating disputes arising under the parties’ subscription agreement in any jurisdiction other than the parties’ chosen forum–Delaware.
In 2009, NIG sued Carlyle in Kuwait after NIG suffered losses in connection with investments made in a fund affiliated with Carlyle pursuant to one or more subscription agreements. In response, Carlyle brought an action in the Delaware Court of Chancery to enjoin NIG from filing or prosecuting any action arising from the subscription agreement in a forum other than Delaware in accordance with an exclusive forum selection clause contained in each subscription agreement. NIG failed to respond to Carlyle’s complaint despite repeated notice of the proceedings in Delaware. Subsequently, the Delaware Court of Chancery granted a default order of injunction in Carlyle’s favor and denied a motion by NIG to vacate the injunction order.
On appeal, the Delaware Supreme Court affirmed the Court of Chancery’s denial of NIG’s motion to vacate. NIG argued that Delaware did not have personal jurisdiction over it because the parties failed to obtain a license to sell securities as required by Kuwaiti law rendering the issuance of shares under the subscription agreement invalid. The Court of Chancery held that NIG could not use an argument that the substantive provisions of the underlying contract were invalid to evade personal jurisdiction where the forum selection clause itself was valid. The Delaware Supreme Court agreed. Under the Delaware Supreme Court’s decision in Ingres Corp. v. CA, Inc., forum selection clauses are “presumptively valid” and should be specifically enforced unless the resisting party shows that “enforcement would be unreasonable and unjust, or that the clause [is] invalid for such reasons as fraud and overreaching.” NIG did not make such a showing. NIG also argued the Court of Chancery did not have subject matter jurisdiction to order specific performance of the forum selection clause because Carlyle had an adequate remedy at law. The Delaware Supreme Court disagreed. The Court found that Carlyle would suffer irreparable harm if it were required to enforce the forum selection clause in Kuwait and that Carlyle had no other adequate remedy other than an anti-suit injunction.
Chancery Court Holds Board Process Unreasonable Under Revlon, But Denies Injunction
Document: Koehler v. NetSpend Holdings, Inc., C.A. No. 8373-VCG (Del. Ch. May 21, 2013)
The Delaware Court of Chancery found that the plaintiffs demonstrated a reasonable likelihood of success on the merits of their claim that the single-bidder sales process undertaken by the board of directors of NetSpend Holdings, Inc. (“NetSpend”), in connection with the sale of NetSpend to Total Systems Services Inc. (“TSS”), constituted a breach of the board’s fiduciary obligations under Revlon. However, because no other potential bidders emerged post-signing and the issuance of an injunction might result in NetSpend’s stockholders losing a chance to receive a substantial premium for their shares, the Court denied plaintiffs’ motion for a preliminary injunction.
In February 2013, NetSpend and TSS entered into a merger agreement providing for TSS’s acquisition of NetSpend for $16 per share in cash. This price represented a 26% premium to the then trading price of NetSpend’s stock. JLL Partners Inc. (“JLL”) and Oak Management Corp., NetSpend’s two largest stockholders, committed to vote forty percent (40%) of NetSpend’s outstanding stock in favor of the merger pursuant to a voting agreement with TSS. The merger agreement contained a 3.9% termination fee, a no-shop provision with a fiduciary-out and a superior proposal termination right. However, the merger agreement did not contain a go-shop provision despite NetSpend’s decision to forego a pre-signing market check. NetSpend’s management believed that a market canvas would undermine the company’s continued efforts to convince the market that NetSpend was thriving despite several failed attempts to sell the company in 2007 and 2009. NetSpend’s management also believed that forcing TSS to bid against itself would increase stockholder value. In addition to the deal protection terms in the merger agreement, existing standstill agreements with two private equity firms, which contained don’t-ask-don’t-waive (“DADW”) clauses, presented barriers to a third-party bidder. NetSpend had entered into the standstill agreements in 2012, at the request of JLL, which was then attempting to find a buyer for its minority stake in NetSpend. In this injunction action, plaintiffs alleged that the NetSpend board breached its fiduciary duties of loyalty and care under Revlon, as well as its disclosure obligations. The Court briefly addressed the issue of the disclosure obligations and determined that the plaintiffs failed to meet their burden of proving a likelihood of success on the merits. However, with respect to plaintiffs’ Revlon claims, the Court found that, based on the totality of the circumstances, the board’s decision to pursue a single bidder strategy was not reasonable. In reaching its decision, the Court focused on the deal protection terms in the merger agreement (and, in particular, the absence of a go-shop provision), the existence of DADW clauses in the standstill agreements and the board’s reliance on a weak fairness opinion from Bank of America (“BoA”). With respect to BoA’s fairness opinion, the Court found that: (1) the $16 transaction price was 20% lower than the bottom range of values implied by BoA’s discounted cash flow analysis, (2) BoA’s comparable company analysis compared NetSpend to companies which were dissimilar to NetSpend, and (3) the comparable transactions analysis used old data. With respect to the DADW clauses in the standstill agreements, the Court faulted the NetSpend board for not revisiting the clauses once it entered into negotiations with TSS.
Chancery Court Upholds Single Bidder Negotiation Strategy
The Court found that there was not a reasonable likelihood that plaintiffs would be successful on the merits of their claims that the board of directors of Plains Exploration & Production Company (“Plains”) breached its fiduciary duties by failing to conduct a pre-signing market check or negotiate for a go-shop where the board retained sufficient flexibility under the parties’ merger agreement to pursue a bidder that emerged post-signing.
In December 2012, Plains entered into a merger agreement to be acquired by Freeport-McMoRan Copper & Gold Inc. (“Freeport”) in a mixed stock and cash transaction with a combined value of approximately $50.00 per share. In the months leading up to the signing of the merger agreement, Plains walked away from the deal several times and did not seek out alternative bidders because the board strongly believed in Plains’ success as a stand-alone company. However, Plains eventually agreed to a deal with Freeport after Freeport increased the attractiveness of its offer price and agreed to modest deal protection terms which would allow Plains to pursue superior offers post-signing.
In this injunction action, plaintiffs alleged that the Plains board breached its fiduciary duties, under Revlon, as well as its disclosure obligations. The gravamen of plaintiffs’ Revlon claims was that the Plains board did not conduct a pre-signing market check, did not obtain a go-shop, and did not have the type of impeccable knowledge of the market that would just a single-bidder strategy. The Court found plaintiffs’ allegations insufficient to establish a reasonable probability that board’s decision-making process was inadequate or its actions were unreasonable under the circumstances. With respect to the board’s single-bidder strategy, the Court stated that a board may rely on a post-signing market check to fulfill its Revlon obligations absent impeccable knowledge of the market if the deal protection terms are modest and the board is competent and informed. In this case, the Plains board could (1) pursue a competing bid that “could reasonably be expected to lead” to a superior proposal under a fiduciary-out provision in the merger agreement, and (2) terminate the merger agreement to consummate a transaction with a topping bidder upon payment of a modest 3% termination fee. Thus, the deal protection terms were modest. The Court also found the board to be informed and did not fault the board for delegating the task of negotiating the deal to the company’s CEO (James Flores), who had agreed to stay on as an executive of the combined company following the merger. In the Court’s view, the board’s decision to delegate the negotiations to Flores was appropriate because: (1) the Plains board (a majority of the members of which were independent and disinterested) oversaw the negotiations, (2) Flores’ significant stock ownership aligned his interests with the interests of Plains stockholders generally, and (3) Flores possessed the best knowledge of the company’s business.
Before denying the plaintiffs’ motion for a preliminary injunction in its entirety, the Court addressed the disclosure claims in the complaint. The Court rejected plaintiffs’ argument that defendants breached their fiduciary duty of disclosure, inter alia, by failing to disclose in the proxy statement, unlevered cash flow projections derived by Plains’ investment banker (Barclays) in connection with rendering its fairness opinion on the merger. The proxy statement did disclose the underlying discretionary cash flow numbers which were prepared by Plains management and used by Barclays to derive unleveraged cash flows. In the Court’s view, the Barclay’s derived numbers were immaterial where the stockholders had management’s inside view of the company’s future financial performance.
Chancery Court Outlines Directors’ Obligations in Connection with Private Stock Sales
Document: In re Wayport Inc. Litig., Consol. C.A. No. 4167-VCL (Del. Ch. May 1, 2013)
The Delaware Court of Chancery resolved a conflict in authority over the circumstances under which a director of a Delaware corporation owes a fiduciary duty to disclose material information known to such director by virtue of his position in connection with a private stock sale between the director and a stockholder of the corporation. The Court held that Delaware follows the “special facts doctrine” under which a fiduciary’s failure to disclose material information to a selling stockholder relating to prospective or pending corporate events could constitute a breach of fiduciary duty if the corporate events substantially affect the value of the corporation’s stock and the failure to disclose the events constituted a deliberate attempt to mislead the stockholder.
In this case, the Court considered, inter alia, whether members of the board of directors of Wayport Inc. (“Wayport”) were required to disclose Wayport’s likely sale of a portion of its patent portfolio during private negotiations between affiliates of the board members and plaintiffs for the purchase of plaintiffs’ Wayport stock. The stock sales were consummated in June and September 2007. During the negotiations, plaintiff Brett Stewart, a former CEO and board member of Wayport, repeatedly expressed concern that he was negotiating at a disadvantage because, unlike the buyers, he was not an officer or director of Wayport or an affiliate of such persons. On June 8, 2007, one of the defendants tried to appease Stewart by sending him an email which stated that there were no “bluebirds of happiness in the Wayport world[.]” In actuality, Wayport was then negotiating the divestiture of a number of its patents (the “Patents”) with two potential bidders. Several days later, plaintiffs sold stock to defendants without being informed about the possible sale of the Patents. On June 27, 2007, Wayport executed a definitive agreement with Cisco for the sale of the Patents (the “Sale”). In September 2007, plaintiffs sold additional stock to the defendants without knowledge of the Sale.
In this action, plaintiffs alleged, inter alia, that the defendants breached a fiduciary duty of disclosure by failing to disclose the Sale. In its post-trial opinion, the Court rejected the plaintiffs’ fiduciary claims, but found for plaintiffs with respect to a common law fraud claim. In the Court’s view, the Sale was a “milestone in the Company’s process of monetizing its patent portfolio and it was sufficiently large to enter into the decision-making of a reasonable stockholder.” However, for plaintiffs to prevail under the special facts doctrine, they also had to prove that the Sale substantially affected the value of their stock. At trial, Stewart admitted that the Sale may not have significantly impacted the value of Wayport’s stock because the company’s remaining assets were substantial.
However, the Court did find that one of the defendants was liable for common law fraud in connection with the “bluebirds” email.
Chancery Court Holds That a Party’s Exercise (or Failure to Exercise) an Express Contractual Right Cannot Give Rise to a Fiduciary Claim
Document: Blaustein v. Lord Baltimore Capital Corp., C.A. No. 6685-VCN (Del. Ch. Apr. 30, 2013)
The Court considered the extent to which the implied covenant of good faith and fair dealing could be used by a stockholder in a closely-held, Delaware corporation to force the corporation to repurchase her stock at any price in the absence of an express contractual obligation on the part of the corporation to facilitate the stockholder’s exit of her investment in the company.
In this action, a stockholder of Defendant Lord Baltimore Corporation (“Lord Baltimore”) asserted both contract and fiduciary claims against Lord Baltimore in connection with the stockholder’s unsuccessful attempts to liquidate her investment in the company. A stockholders’ agreement prevented plaintiff from transferring her shares in most circumstances. Section 7(d) of the stockholders agreement permitted, but did not require, Lord Baltimore to repurchase plaintiff’s shares:
Notwithstanding any other provision of this Agreement, the Company may repurchase Shares upon terms and conditions agreeable to the Company and the Shareholder who owns the Shares to be repurchased provided that the repurchase is approved either (i) by a majority, being at least four, of all of the Directors of the Company then authorized (regardless of the number attending the meeting of the Board of Directors) at a duly called meeting of the Board of Directors or (ii) in writing by Shareholders who, in the aggregate, own of record or beneficially 70% or more of all Shares then issued and outstanding.
Slip op. at 6. After numerous attempts to negotiate for the repurchase of her stock by Lord Baltimore failed, plaintiff sued Lord Baltimore and alleged that Lord Baltimore’s failure to repurchase her shares at a reasonable price constituted a breach of the implied covenant of good faith and fair dealing and a breach of fiduciary duty. The Court disagreed and held that the implied covenant could not be construed as requiring Lord Baltimore to negotiate with plaintiff—let alone require Lord Baltimore to accept a reasonable repurchase proposal. The Court also held that where, as here, a fiduciary claim arises from a corporation’s exercise (or failure to exercise) a contractual right, the fiduciary claim is precluded. Thus, it was totally irrelevant whether the board’s decision to reject plaintiff’s repurchase proposals were tainted by self-interest—the Lord Baltimore board could reject plaintiff’s repurchase proposal regardless of its reasons.
Caremark Claims Relating to Board’s Oversight of Company’s China Operations Survive a Motion to Dismiss
Document: George Rich, Jr. v. Yu Kwai Chong, et al., C.A. No. 7616-VCG (Del. Ch. Apr. 25, 2013)
The Delaware Court of Chancery denied defendant directors’ motion to dismiss plaintiffs’ claims that the directors breached their fiduciary duties under Caremark by failing to establish sufficient internal controls and ignoring “red flags” in connection with the corporation’s operation of a jewelry company based in China. This action followed on the heels of the company’s public announcement in 2010, of the likely restatement of its 2009 financial statements and the apparent disappearance of $120 million of the company’s cash (the entire amount it received in a 2009 public offering), which apparently had been transferred (upon the CEO’s oral instructions) to third persons in China whose business addresses could not be verified.
Nominal defendant Fuqi International, Inc. (“Fuqi”), whose sole asset consists of stock in a Chinese jewelry company, completed a U.S. public offering in 2009. The public offering followed a reverse triangular merger pursuant to which Fuqi gained access to U.S. capital markets. In March 2010, Fuqi announced that, due to deficiencies in internal controls, the filing of its fourth quarter 10-Q and its 10-K for 2009 would be delayed. In July 2010, plaintiff made a demand on Fuqi’s board to remedy alleged breaches of fiduciary duties in connection with the deficiencies in the company’s internal controls. By September 2010, the Securities and Exchange Commission (“SEC”) began investigating Fuqi for failure to file timely periodic reports. In October 2010, Fuqi formed a special committee of directors to respond to plaintiff’s allegations. However, Fuqi continued to have trouble controlling its finances and, in 2011, Fuqui announced that it would be restating many of its previously filed financial statements because of accounting errors. Fuqi also announced that its audit committee was investigating cash-transfer transactions to third parties in China which totaled over $120 million and for which there were no written records. The audit committee later abandoned its investigation after several of its members resigned and its advisors quit.
Plaintiff commenced this action in June 2012, after receiving no response from the Fuqi special committee formed to investigate his allegations. Defendants moved to dismiss plaintiff’s complaint for failure to state a claim and on the basis that plaintiff could not proceed with this action until Fuqi responded to his demand under Chancery Court Rule 23.1. The Court disagreed and found that the requirements of Rule 23.1 had been satisfied because plaintiff’s complaint raised a reasonable doubt that the board had acted in good faith under a Caremark theory of liability. The Court also found that plaintiff’s complaint stated a claim for breach of the duty of loyalty arising from the Fuqi directors’ failure to exercise oversight over the company’s finances. In this case, the Court found that Fuqi’s own public filings allowed the Court to infer that: (1) Fuqi had no meaningful controls in place, and (2) Fuqi’s board members were aware of, but knowingly failed to address, the pervasive inadequacies in the company’s internal controls.
Chancery Court Enjoins Board from Impeding Proxy Contest
Document: Kallick v. Sandridge Energy, Inc., C.A. No. 8182-CS (Del. Ch. Mar. 8, 2013)
The Delaware Court of Chancery enjoined an incumbent board from impeding a proxy contest until the board approved the dissent slate for purposes of a change in control provision in the corporation’s debt instruments. If the dissident slate were elected by the corporation’s stockholders without the incumbent board’s prior approval, the corporation’s creditors would have the right to require the corporation to repurchase its own debt. The incumbent board’s approval of the dissident slate for purposes of the change in control provision would not have (but for the court’s action) limited the incumbent board’s ability to run its own campaign. In reaching the decision to issue an injunction, the Court first found that the incumbent directors had likely breached their fiduciary duties in declining to approve the dissident slate for purposes of the change in control provision in the debt instruments because the directors could not identify any specific and substantial risk to the corporation or its creditors posed by the election of the rival slate. Reviewing the board’s actions under Unocal, the Court found that the incumbent directors’ belief that they were better qualified or had better plans for the corporation than the rival slate did not justify the potential coercion of the stockholder vote in the incumbents’ favor as a result of fear-mongering over the triggering of the put right. Because damages for the board’s breach of fiduciary duty would be difficult to calculate and the injunction request was narrowly tailored, the Court found that all of the conditions for a preliminary injunction were satisfied.
Chancery Court Declines to Expedite Claim that Deal Protection Provisions Were Preclusive of Other Offers
Document: In Re BioClinica, Inc. Shareholder Litig., C.A. No. 8272-VCG (Del. Ch. Feb. 25, 2013)
The Delaware Court of Chancery declined to expedite plaintiffs’ claims that the board of directors of BioClinica, Inc. (“BioClinica”) breached its fiduciary duties by entering into merger and standstill agreements that relegated potential interlopers to making a tender offer for BioClinica. BioClinica also had a stockholder rights plan in place at the time it agreed to be acquired by JLL Partners, Inc. (“JLL”), the transaction at issue, which would be triggered upon the announcement of a tender offer by any person other than JLL. In reaching its decision, the Court noted that the triggering of the pill’s “flip in” provisions would give BioClinica’s stockholders the option to purchase $7.25 in preferred stock for $16.00. Because no rational stockholder would exercise the flip-in right, and the BioClinica board could terminate the merger agreement to pursue a superior proposal and redeem the pill at any time prior to a competing bidder acquiring 20% of its stock, the plaintiffs’ claims that the deal protection devices were preclusive of other offers, were not colorable.
Chancery Court Finds Corporation Did Not Violate Anti-Assignment Clause in a Licensing Agreement by Merging
Document: Meso Scale Diagnostics, LLC v. Roche Diagnostics GMBH, C.A. No. 5589–VCP (Del. Ch. Feb. 22, 2013)
The Delaware Court of Chancery rejected plaintiffs’ claim that the surviving corporation to a merger breached an anti-assignment clause in a licensing agreement when it agreed to be acquired in a reverse triangular merger without plaintiffs’ consent. In the merger, a wholly owned subsidiary of the acquiror merged with and into the corporation with the corporation surviving the merger as a wholly owned subsidiary of the acquiror. The contract at issue specifically prohibited assignments “by operation of law.” The Court stated that there was no transfer of the intellectual properties rights at issue by operation of law in connection with the reverse triangular merger because the surviving corporation to a merger is the same legal entity as the original contracting party.
Chancery Court Declines to Dismiss Claims That Directors Breached Their Fiduciary Duties by Resigning from Board of a Troubled Company
Re Puda Coal, Inc., Stockholders Litig., C.A, No. 64676-CS (Del. Ch. Feb. 6, 2013) (TRANSCRIPT)
The Delaware Court of Chancery declined to dismiss a Caremark claim, among others, brought against the board of directors of a China-based corporation, Puda Coal, Inc. (“Puda”). Puda’s three, U.S.-based, independent directors resigned after learning of plaintiffs’ complaint and allegations that Puda’s chairman and fellow board member secretly transferred control of the company’s sole source of revenue to himself 18 months earlier. The independent directors’ resignations left control of Puda’s board and management in the hands of the alleged thief in China. The Court cautioned persons who agreed to serve as directors of Delaware corporations with substantial operations and assets in other countries with the following:
If you are going to have a company domiciled for purposes of its relations with its investors in Delaware and the assets and operations of the company situated in China that, in order for you to meet your obligation of good faith, you better have your physical body in China an awful lot. You better have a system of controls to make sure that you know that you actually own the assets. You better have the language skills to navigate the environment in which the company is operating….What you can’t be is a dummy director in the sense of an actual dummy. Like somebody, a mannequin, somebody who allows themselves to be appointed something without any serious effort to fulfill duties…. I’m talking about the loyalty issue of understanding that if the assets are in Russia, if there’re in Nigeria, if they’re in the Middle East, if they’re in China, that you’re not going to be able to sit in your home in the U.S. and do a conference call four times a year and discharge your duty of loyalty.
In addition to finding that plaintiffs had stated a Caremark-style claim for breach of their oversight function, the Court found that plaintiffs had stated a claim that the independent directors breached their fiduciary duties by resigning when they learned about the allegations in the plaintiffs’ complaint.
Chancery Court Dismisses Fiduciary Claims Relating to Alleged Disparate Treatment of Strategic and Private Equity Buyers
Document: In re BJ’s Wholesale Club, Inc. Shareholders Litig., C.A. No. 6623-VCN (Del. Ch. Jan. 31, 2013)
The Delaware Court of Chancery dismissed plaintiffs’ claim that the members of the board of directors of BJ’s Wholesale Club, Inc. (“BJ’s”) breached their fiduciary duties in connection with the sale of BJ’s to a consortium of private equity funds led by Leonard Green & Partners, L.P. (“LGP”). The plaintiffs’ complaint focused on the board’s alleged disparate treatment of strategic and private equity bidders.
In July 2010, BJ’s board began to explore strategic alternatives after LGP signaled its interest in a private buyout of the company by disclosing its nearly 10% position in BJ’s common stock. From July 2010 until February 2011, BJ’s negotiated exclusively with LGP. In February 2011, BJ’s made its search for strategic alternatives public and Party A, a strategic competitor, expressed an interest in acquiring BJ’s at a price higher than the price then-offered by LGP and its two partners (the “Buyout Group”). However, BJ’s repeatedly rebuffed Party A’s interest and signed a definitive agreement with the Buyout Group in June 2011, because: (1) Party A had no history of acquiring domestic corporations, (2) BJ’s was wary of sharing non-public information with a direct competitor, and (3) a merger with a direct competitor posed anti-trust issues.
In this action, plaintiffs alleged that BJ’s treatment of Party A, inter alia, supported a Revlon claim. Because a majority of the members of BJ’s board were disinterested/independent and BJ’s certificate of incorporation contained an exculpatory provision for breaches of the fiduciary duty of care, plaintiffs’ claims could only survive a motion to dismiss if the board acted in bad faith. According to the Court, a Revlon claim premised on bad faith, requires an inference that the defendants “utterly failed” to attempt to obtain the best sales price. Here, the Court found that there were plausible explanations for the disparate treatment that supported the board’s decision on grounds other than bad faith—i.e., that Party A was a competitor etc. The Court also rejected as evidence of bad faith, the fact that BJ’s apparently distributed a proxy statement to its stockholders which stated that no strategic buyer showed any interest in acquiring BJ’s.