Delaware Transactional Law Updates

Document: In re Mobilactive Media, LLC, C.A., No. 5725-VCP (Del. Ch. Jan. 25, 2013)

The Delaware Court of Chancery found that a party to a joint venture usurped corporate opportunities belonging to the joint venture and therefore breached its fiduciary duty of loyalty.  In so finding, the Court held that plaintiff did not need to establish two of the four elements of a corporate opportunity claim based on a provision in the parties’ joint venture agreement.

In 2007, Terry Bienstock, the former general counsel of Comcast Cable Communications, formed a joint venture (Mobilactive Media, LLC (“Mobilactive”)) with Silverback Media, PLC, a UK listed company (“Silverback”), for the purpose of developing and licensing technology for the enhancement of advertising content.  Section 13.5 of Mobilactive’s limited liability company prohibited the parties from pursing outside business ventures in Mobilactive’s line of business:

The members agree that the Company and its subsidiaries shall be the only means through which any member or any of its Affiliates engage in the Business and that any opportunity for new or expanded Business that any Member or its affiliates learn shall be presented to the Company as an opportunity for the Company.

By 2010, Silverback desired to renegotiate Section 13.5 or terminate the joint venture to pursue competing business ventures.  After Bienstock rejected Silverback’s proposals, Silverback filed a complaint in the Delaware Court of Chancery for the dissolution of Mobilactive.  In response, Bienstock filed the complaint in this action, which alleged that Silverback had already consummated a number of business development transactions that breached Section 13.5.

In a decision after trial, the Court found that Silverback usurped corporate opportunities in breach of Section 13.5 and in violation of Silverback’s fiduciary duty of loyalty.  The Court held that the parties’ agreement permitted the Court to presume two of the four elements of a corporate opportunity claim—that Mobilactive had an interest or expectancy in the opportunities and was financially able to exploit the opportunities.  Based on the facts before it, the Court also was able to conclude that the opportunities were within Mobileactive’s line of business and that, by taking the opportunity, Silverback acted contrary to its fiduciary duties, the remaining elements of a corporate opportunity claim.  The Court awarded Bienstock $3 million in damages.

Document: Gerber v. EPE Holdings, LLC, C.A. No. 3543-VCN (Del. Ch. Jan. 18, 2013)

The Delaware Court of Chancery held that a limited partnership agreement effectively supplanted a general partner’s common law fiduciary duties with contractually defined standards by providing that the general partner had no duties or obligations, including fiduciary duties, to the limited partnership or its limited partners, except as provided in the limited partnership agreement.

In this action, plaintiff, a limited partner of Enterprise GP Holdings, L.P. (“EPE”), alleged that EPE’s general partner, EPE Holdings, LLC (“Holdings”), breached an obligation owed to the limited partners to act in good faith in connection with EPE’s purchase of Texas Eastern Products Partners, LLC (“Teppco”) from an affiliate of Holdings.  Holdings’ conflicts committee approved the acquisition of Teppco pursuant to Section 7.9(a) of EPE’s limited partnership agreement, which provided that Holdings breached no contractual or fiduciary obligation to EPE’s limited partners by entering into so-called “conflict transactions” if the transactions were approved by the conflicts committee.  In this action, plaintiffs contended that the conflicts committee’s approval of the acquisition of Teppco by EPE was ineffective to immunize the transaction under Section 7.9(a) because the conflicts committee acted in bad faith.  Section 7.9(a) did not expressly require the conflicts committee to act in good faith.  However, the plaintiff claimed that the good faith obligation arose under (1) the implied covenant of good faith and fair dealing, and (2) a separate provision in the limited partnership agreement that required Holdings and its affiliates to act in good faith when making determinations impacting EPE.  Moreover, the plaintiff maintained that the test whether the conflicts committee acted in good faith was a question of objective reasonableness.

The Court rejected plaintiff’s claims and dismissed the complaint.  According to the Court, the implied covenant of good faith and fair dealing precludes a party from using its discretion under a contract in a manner that utterly frustrates the other party’s reasonable expectations at the time of contracting, but does not require a party to act in a manner that is objectively reasonable.  The Court also found that a provision requiring Holdings and its affiliates to act in “good faith” when making determinations impacting EPE did not impose an obligation to act reasonably from an objective point of view.  According to the Court, at most, the contractual obligation to act in good faith required the conflicts committee to act with the subjective belief that the acquisition of Teppco was in the best interests of EPE.  Because plaintiff had not pled any facts indicating that the members of the conflicts committee subjectively believed that the acquisition of Teppco was contrary to EPE’s best interests, the Court rejected plaintiff’s claim for breach of the agreement.

Document: In re Novell, Inc. Shareholders Litig., C.A. No. 6032-VCN (Del. Ch. Jan. 3, 2013)

The Delaware Court of Chancery held that plaintiffs had stated a claim that the members of the board of directors of Novell, Inc. (“Novell”) acted in bad faith by preferring one bidder to another in connection with the sale of Novell to Attachmate Corporation (“Attachmate”) in a transaction worth approximately $2.2 billion.

In March 2010, the Novell board initiated an eight-month, exploratory sales process following receipt of an offer from a minority stockholder, Elliott Associates, LP (“Elliott”), to acquire the company at a price which the Novell board deemed inadequate.  J. P. Morgan, Novell’s financial advisor, contacted over fifty potential buyers, and more than thirty of the contacted parties entered into a non-disclosure agreement with Novell, including Attachmate.  In August 2010, the Novell board requested that Attachmate and a private equity firm (“Party C”) submit their best and final offer, and Novell subsequently granted Attachmate exclusivity despite having received a higher offer from Party C.  However, the period of exclusivity ran out without Novell and Attachmate agreeing to a deal.  In October 2010, Novell received a revised offer from Attachmate on the same day as it received an unsolicited, revised offer from Party C, which proposal was again higher than the offer submitted by Attachmate.  Shortly thereafter, Microsoft Corporation submitted an offer to acquire certain of Novell’s patents for $450 million, and Novell approached Attachmate, but not Party C, about acquiring the company exclusive of the patents.  Attachmate raised its bid conditioned on the consummation of the patent sale, and Novell and Attachmate entered into a merger agreement on November 21, 2010.

In this action, plaintiffs alleged, inter alia, that the Novell board breached its fiduciary duties by preferring Attachmate to Party C in the sales process.  Specifically, plaintiffs alleged that the Novell board breached its fiduciary duties by failing to (1) follow-up with Party C about either of its competing bids, and (2) approach Party C about a bid for the sale of the company exclusive of the patents following Microsoft’s $450 million cash bid for the patents.  Because a majority of the members of the Novell board were disinterested and independent and Novell’s certificate of incorporation contained an exculpatory provision authorized by Section 102(b)(7) of the General Corporation Law of the State of Delaware, plaintiffs’ fiduciary claims could only survive a motion to dismiss if they supported an inference of bad faith conduct by the Novell board.  On the record before it, the Court found inexplicable on any grounds other than bad faith, the board’s failure to pursue Party C’s offers.  The Court acknowledged that there might be plausible and justifiable reasons for Novell treating Attachmate differently than other bidders, but it could not make that judgment at this stage in the proceedings.  Thus, the Court denied defendants’ motion to dismiss the claim.

Document: Winshall v. Viacom International Inc., C.A. No. 6074-CS (Del. Ch. Dec. 12, 2012)

The Delaware Court of Chancery ordered Viacom International Inc. (“Viacom”) to release merger consideration held in escrow since 2006 for the benefit of the former stockholders of Harmonix Music Systems (“Harmonix”), a developer of music-based video games.  Following the closing of its acquisition of Harmonix, plaintiff repeatedly requested that Viacom release the escrowed funds for distribution to Harmonix’s stockholders pursuant to the terms of the parties’ merger agreement.  Viacom refused to release the funds on the basis that it had a claim to all of the escrow funds pursuant to a provision in the merger agreement that entitled it to indemnification for legal fees from the escrow funds if Harmonix breached its representations and warranties and the breach caused Viacom to incur legal fees.  According to Viacom, Harmonix breached representations and warranties relating to Rock Band, a video game which Harmonix was still developing at the time of the execution of the merger agreement.  Specifically, Harmonix represented that that it had “adequate [intellectual property] rights” for the “current use” of “any [g]ames in development.”  After Viacom released Rock Band in 2007, several parties sued Viacom and alleged that the final, published version of Rock Band infringed their intellectual property rights.

In December 2010, plaintiff, as the stockholders’ representative under the parties’ merger agreement, initiated this action and sought to force Viacom to release the escrow funds.  Viacom defended this action on the basis that it was entitled to be indemnified out of the escrow funds for its legal fees incurred in defending claims related to Rock Band.  In determining whether Viacom had any entitlement to indemnification from the escrow funds for its defense costs, the Court reviewed the plain terms of the merger agreement.  According to the Court, the merger agreement permitted Viacom to be indemnified for defense costs only if the costs arose from an actual breach of Harmonix’s representation and warranties.  Because the patent infringement actions all related to the final, published version of Rock Band, as to which Harmonix made no representations in the parties’ merger agreement, the Court found that Harmonix had not breached the merger agreement, and Viacom was therefore not entitled to indemnification from the escrow funds.

Document: Duff v. Innovative Discovery LLC, C.A. No. 7599-VCP (Del. Ch. Dec. 7, 2012)

The Delaware Court of Chancery confirmed that it may exercise subject matter jurisdiction over matters which the Delaware Limited Liability Company Act (the “LLC Act”) specifies “may be brought in the Court of Chancery” regardless of whether the Court would otherwise have subject matter jurisdiction over such matters. In other words, the Court held that any action of a type enumerated in Section 18-111 of the LLC Act, may be brought in the Court of Chancery even if such action seeks no equitable relief or invokes no equitable rights. Further, once the Court of Chancery possesses jurisdiction by virtue of Section 18-111 of the LLC Act, the Court held that it may exercise subject matter jurisdiction over related claims even if the related claims are not equitable in nature. Section 18-111 of the LLC Act vests the Court of Chancery with subject matter jurisdiction over a number of types of actions, including proceedings to “interpret, apply or enforce the provisions of a limited liability company agreement, or the duties, obligations or liabilities of the limited liability company to the members or managers of the limited liability company[.]”

Document: Hite Hedge LP v. El Paso Corp., C.A. No. 7177-VCG (Del. Ch. Oct. 9, 2012)

The Delaware Court of Chancery dismissed fiduciary claims asserted by the limited partners of a master limited partnership, El Paso Pipeline Partners, L.P. (“EPB”), against El Paso Corporation (“El Paso”), as the controller of EPB’s general partner, because, inter alia, EPB’s partnership agreement contractually eliminated El Paso’s common-law fiduciary duties to EPB’s limited partners.

EPB provides natural gas transportation pipelines and storage.  Until 2011, EPB acquired pipeline and related assets at favorable prices from El Paso, and EPB’s growth was dependent on receiving its assets from El Paso.  In 2011, Kinder Morgan, Inc. (“Kinder Morgan”) acquired El Paso.  At the time of the merger, Kinder Morgan announced that it would be selling El Paso’s pipeline assets to an affiliate of Kinder Morgan.  In this ensuing litigation, plaintiffs claimed that El Paso breached its fiduciary duties to EPB’s limited partners by agreeing to a merger that would result in decreased asset drop-downs to EPB.  In other words, plaintiffs argued that El Paso extracted value from EPB at the expense of EPB’s limited partners.  The Court rejected plaintiff’s claims by finding that: (1) El Paso owed no fiduciary duties to EPB’s limited partners under the plain language of EPB’s limited partnership agreement, and (2) even if El Paso did owe EPB’s minority holders fiduciary duties, El Paso did not breach those duties in choosing how to exercise control over its own assets.

Document: Louisiana Municipal Police Employees’ Retirement Sys. v. Lennar Corp., C.A. No. 7314-VCG (Del. Ch. Oct. 5, 2012)

The Delaware Court of Chancery found that  media reports of an industry-wide, federal investigation of potential unfair labor practices by the nation’s home builders, including the defendant, and several previous labor-related lawsuits against defendant, failed to support a books and records action.  In this lawsuit, plaintiff sought to inspect the books and records of Lennar Corp. (“Lennar”), under Section 220 of the DGCL, for purposes of investigating breaches of fiduciary duty under Caremark, in connection with Lennar’s labor practices.  Lennar rejected plaintiff’s demands for books and records on the basis that plaintiff did not present a credible basis from which any wrongdoing on the part of Lennar could be inferred.  Lennar then moved for summary judgment.

The Court granted Lennar’s motion for summary judgment for the following reasons.  Under Section 220 of the DGCL and the common law, a stockholder of a Delaware corporation is entitled to inspect the books and records of the corporation if the stockholder (1) identifies a “proper purpose” for the demand, and (2) supports the demand with a “credible basis” from which the court can conclude an investigation is warranted.  Here, the Court held that plaintiff’s purpose for making the demand—to investigate ongoing compliance with labor laws for purposes of bringing a Caremark claim—constituted a “proper purpose” under Delaware law.  However, the Court held that plaintiff had failed to show a credible basis for its allegations of wrongdoing.  Relying on prior precedent, the Court rejected plaintiff’s argument that several lawsuits filed against Lennar between 2007 and 2009, but later settled by Lennar without an admission of culpability, provided evidence of wrongdoing.  Further, the Court found unpersuasive several newspaper articles which simply reported that Lennar was one of many companies being investigated by federal agencies in connection with an industry-wide investigation of possible violations of federal labor laws.

Document: Shocking Technologies, Inc. v. Michael, C.A. No. 7164-VCN (Del. Ch. Sept. 28, 2012)

The Delaware Court of Chancery found that a director and stockholder of a Delaware corporation breached his duty of loyalty to the corporation by interfering with the cash-strapped corporation’s efforts to obtain funding and by disclosing confidential corporate information to potential investors in an effort to increase his control over the corporation.  However, the corporation was unable to show that it suffered any loss as a result of the breaches of fiduciary duty.  In addition, the Court found that the director subjectively believed that his actions were in the best interests of the corporation.  Accordingly, the Court declined to award the plaintiff damages or attorneys’ fees.

Document: Greenmont Capital Partners I, LP v. Mary’s Gone Crackers, Inc., C.A. No. 7265-VCP (Del. Ch. Sept. 28, 2012)

The Delaware Court of Chancery dismissed a claim that sought to unwind the conversion of plaintiff’s preferred stock into common stock, where the defendant’s certificate of incorporation specifically authorized the conversion at issue.  The certificate of incorporation of Mary’s Gone Crackers, Inc. (“MGC”) contained a provision that triggered an automatic conversion of all of the corporation’s preferred stock into common stock upon the affirmative vote of the holders of a majority of the outstanding Series A preferred stock and Series B preferred stock, voting together as a class.  On February 17, 2012, MGC received the requisite consent of its preferred stockholders for the conversion and proceeded to amend its certificate of incorporation to eliminate the provisions of its certificate of incorporation which related to its previously outstanding preferred stock.  MGC did not seek the vote of any MGC stockholder in connection with the elimination of the preferred stock terms, by amending the charter of MGC, as permitted by Section 151(g) of the General Corporation Law of the State of Delaware (the “DGCL”).

Plaintiff, a former holder of Series B preferred stock, argued that the forced conversion and subsequent elimination of the preferred stock terms were unlawful without a separate class vote of the holders of Series B preferred stock under Section D.2(b) of MGC’s certificate of incorporation (“Section D.2(b)”).  Prior to its elimination, Section D.2(b) required MGC to obtain the vote of the holders of Series B preferred stock prior to effecting “any agreement or action that alters or changes the voting rights or other powers, preferences or other special rights” of the Series B preferred stock.  The Court found that Section D.2(b) did not provide the holders of Series B preferred stock with a blocking right in connection with the conversion of the preferred stock or subsequent elimination of the terms of the preferred stock from MGC’s certificate of incorporation.

According to the Court, Section D.2(b) did not limit the application of the automatic conversion provision because the automatic conversion provision was itself a special right of the holders of MGC’s preferred stock.  In other words, the conversion was effected by the exercise of an existing right of the holders of preferred stock, not the alteration or change of any right.  The Court also held that Section D.2(b) did not limit MGC’s authority to eliminate the preferred stock terms under the DGCL because the Series B preferred stock was not outstanding at the time of the charter amendment.

Document: South v. Baker, C.A. No. 7294-VCL (Del. Ch. Sept. 25, 2012)

The Delaware Court of Chancery dismissed a complaint alleging that the board of directors of Hecla Mining Company (“Hecla”) knowingly caused the corporation to violate federal safety regulations applicable to mining companies.  In 2011, the United States Mine Safety and Health Administration investigated and fined Hecla after several accidents occurred at Hecla’s mines.  A number of derivative lawsuits ensued, including this action.

Ruling on plaintiffs’ motion to dismiss, the Court noted that the complaint failed to cite any connection between acts or omissions of the Hecla board and Hecla’s violation of health and safety laws.  Specifically, the complaint did not allege any facts from which a decision by the Hecla board to knowingly violate the law could be inferred.  Further, according to the Court, the complaint did not contain allegations from which it could infer a systemic failure of the board’s oversight function.  To the contrary, plaintiffs affirmatively pled that the Hecla board created a committee to monitor safety and environmental issues at Hecla’s mines.  Thus, the Court dismissed the complaint for failure to establish futility of demand and admonished future plaintiffs to use a Section 220 action to investigate potential Caremark claims before filing a derivative action.

Document:  Impact Investments Colorado II, LLC and Baker Investment Trust v. Impact Holding, Inc., C.A. No. 4323-VCP (Del. Ch. Aug. 31, 2012)

The Delaware Court of Chancery held that the terms of a stock purchase agreement precluded the buyer of a candy manufacturing business from seeking indemnification for certain claims that had been the subject of post-closing negotiations between the parties and had resulted in a post-closing adjustment to the purchase price.

This action arose from the acquisition of all of the outstanding stock of Impact Confections, Inc. (“Impact”) by Brazos Private Equity Partners LLC (“Brazos” or “Buyer”).  In 2008, the holders of all of the outstanding capital stock of Impact (“Sellers”) entered into a stock purchase agreement (the “SPA”) with Brazos.  The SPA provided for a post-closing purchase price adjustment in the event that Impact’s target working capital on the closing date differed from its actual working capital as of such date.  In this connection, the SPA required Buyer to deliver to Seller a statement setting forth the actual working capital of Impact within sixty days of closing and provided a procedure for resolving post-closing purchase price disputes.  In addition, the SPA created an escrow account from which claims for indemnification for breach of representations and warranties concerning Impact would be paid within one year of closing.  Finally, Section 6(f) of the SPA (“Section 6(f)”) limited the Buyer’s ability to seek indemnification for claims taken into account in determining purchase price adjustments, stating that “Sellers shall not be obligated to indemnify Buyer against Adverse Consequences as a result of, or based upon or arising from, any claim or liability to the extent such claim or liability is taken into account in determining any adjustment to the Purchase Price.”

In this case, Buyer argued that Section 6(f) did not foreclose it from pursuing indemnification for expenses which resulted in a purchase price adjustment to the extent the amount sought to be indemnified differed from any post-closing adjustments to the purchase price.  The Sellers argued that Section 6(f) should not be interpreted in a manner that allowed Buyer to rehash disputes negotiated and settled through a purchase price adjustment.  The Court agreed with Sellers and granted summary judgment in favor of Sellers with respect to several disputed expenses that had resulted in purchase price adjustments.  However, the Court declined to grant Sellers’ motion for summary judgment on a number of Buyer’s remaining claims for indemnification relating to alleged errors in the calculation of the components of working capital which had not been actually disputed and negotiated during the purchase price adjustment process.  The Court believed that the resolution of these latter claims could only be resolved after trial.

Document:  In re Encore Energy Partners LP Unitholder Litig., C.A. No. 6347-VCP (Del. Ch. Aug. 31, 2012)

The Delaware Court of Chancery granted defendants’ motion to dismiss plaintiffs’ claims that the general partner of a master limited partnership, Encore Energy Partners LP (the “Partnership”), and the general partner’s directors breached a contractual duty of good faith owed to the Partnership’s unaffiliated unitholders under the Partnership’s limited partnership agreement.  This action arose from the acquisition of the Partnership by Vanguard National Resources LLC (“Vanguard”) for consideration which represented a ten percent discount to the preannouncement trading price of the Partnership’s units.  At all relevant times, an affiliate of Vanguard served as the general partner of the Partnership and was the Partnership’s controlling unitholder.  Because the merger posed a conflict of interest, the general partner sought and obtained approval from its independent directors (collectively, the “Conflicts Committee”) pursuant to a provision in the Partnership’s limited partnership agreement absolving the general partner and its directors from liability for breach of any duty owed at law or equity to the Partnership’s unitholders in connection with a conflict transaction approved by the “Conflicts Committee acting in good faith.”  The Partnership’s limited partnership agreement defined the term “good faith” for these purposes as a determination or other action taken by any person based on the belief that “such determination or other action is in the best interests of the Partnership.”  Relying on precedent interpreting nearly identical language in a partnership agreement, the Court held that the plaintiffs’ claims would fail unless they showed that the Conflicts Committee members subjectively believed that they were acting against the Partnership’s best interests.  According to the Court, plaintiffs’ allegation that the Conflicts Committee was a shoddy negotiator did not meet this standard.

Document: Southern Pennsylvania Transportation Authority v. Volgenau, C.A. No. 6354-VCN (Del. Ch. August 31, 2012)

The Delaware Court of Chancery held that plaintiff’s claims that a merger was void for violation of defendant corporation’s certificate of incorporation were procedurally barred under Section 124 of the Delaware General Corporation Law (“Section 124”).  According to the Court, Section 124 only permits a challenge to corporate acts on the basis of a lack of authority in three limited circumstances: (1) an injunction proceeding brought by a stockholder of the corporation, (2) a proceeding brought by the corporation, whether acting directly or indirectly, through a stockholder in a representative suit, or (3) a proceeding by the attorney general to dissolve the corporation or to enjoin the corporation from the transaction of unauthorized business.  However, the Court allowed plaintiff’s claims that defendants breached their fiduciary duties by approving a merger that violated the corporation’s certificate of incorporation to proceed: “Although corporate actions may be deemed valid [under Section 124], it does not follow, however, that the conduct of those persons who cause such actions to occur may not be challenged on legal or equitable grounds.”

Document: Gentili v. L.O.M. Med. Int’l., Inc., C.A. No. 7600-VCG (Del. Ch. Aug. 17, 2012)

The Delaware Court of Chancery concluded that stockholder consents purporting to ratify the election of directors at an aborted annual meeting of stockholders of L.O.M. Medical International Inc. (“L.O.M.”) were ineffective to elect certain of the defendants as directors of L.O.M (the “Challenged Directors”). On April 17, 2012, L.O.M. attempted to hold an annual meeting of stockholders; however, L.O.M.’s president adjourned the meeting before any action was taken on the election of directors. Subsequently, one of the Challenged Directors purported to preside over a resumed meeting at which the Challenged Directors were allegedly elected directors of L.O.M. Written consents of stockholders holding approximately fifty-three percent (53%) of L.O.M.’s outstanding voting power were later delivered to L.O.M which purported to ratify the election of the Challenged Directors at the resumed meeting. Plaintiffs brought this Section 225 action to confirm that L.O.M’s annual meeting had been validly adjourned and not lawfully reconvened prior to a vote on the election of directors.

Defendants moved to dismiss plaintiffs’ complaint. The Court found that it could only grant defendants’ motion if the stockholder consents ratified an action of the L.O.M. board that, in turn, disposed of the plaintiffs’ contention that the votes were not validly taken at the annual meeting. According to the Court, the stockholder consents were ineffective to accomplish anything. In effect, there was no board action to ratify, and the consents could not themselves be considered “votes” for the election of directors. Under Section 211(b) of the DGCL, stockholders may only elect directors by written consent in lieu of an annual meeting if the consent is unanimous or if all of the corporation’s directorships are vacant and filled by such action. Because the consent at issue in Gentili v. L.O.M. Med. Int’l., Inc. was not unanimous, and all of the directorships to which directors could have been elected at the April 17, 2012 meeting were not vacant, the consent was ineffective to elect directors.

Document:  In re Synthes, Inc. Shareholder Litig., C.A. No. 6452-CS (Del. Ch. Aug. 17, 2012)

The Delaware Court of Chancery rejected plaintiffs’ invitation to apply the entire fairness standard of review to a transaction between a controlled corporation and an unrelated third party where the controller received the same consideration as the minority stockholders in the merger.

This decision involved a challenged to the acquisition of Synthes, Inc. (“Synthes”) by Johnson and Johnson (“J&J”) for approximately $23 billion in stock and cash. The Chairman and controlling stockholder of Synthes, Hansjoerg Wyss (“Wyss”), received the same consideration in the merger as the minority stockholders of Synthes. During the two year period leading up to the merger with J&J in 2012, Sythnes conducted an active search for a buyer and contacted over a dozen potential buyers consisting of both strategic and private equity firms. A consortium of private equity buyers submitted an all-cash bid for a part of the company during the two-year, pre-signing market search. According to plaintiffs, the board of Synthes rejected the partial bid to accommodate the desire of Wyss to retire and achieve a complete divestiture of his interest in Synthes. Because of this alleged conflict, plaintiffs argued that the transaction should be reviewed under the exacting entire fairness standard. Alternatively, the plaintiffs argued that Revlon’s enhanced scrutiny test should apply to the Court’s review of the transaction. The Court held that the business judgment standard was the applicable standard of review. According to the Court, absent facts suggesting that Wyss forced a sale at below fair market value to meet some immediate need for cash, there was no basis to impose entire fairness review on a transaction between a controlled corporation and an unrelated third party because the controller and the minority stockholders were treated the same with respect to the merger consideration. Further, the Court held Revlon inapplicable to a transaction involving the acquisition of a controlled corporation by a corporation with no controlling stockholder for a mix of 65% stock and 35% cash.
Contractual Agreement May Displace the Implied Covenant of Good Faith and Fair Dealing

Document: Policemen’s Annuity and Benefit Fund of Chicago v. DV Realty Advisors LLC, C.A. No. 7204-VCN (Del. Ch. Aug. 16, 2012)

The Delaware Court of Chancery rejected a general partner’s claim that the limited partners of a Delaware limited partnership (the “Partnership”) had a duty to act reasonably when exercising their discretion to remove the general partner, where the Partnership’s operating agreement explicitly provided how the limited partners’ discretion was to be exercised.  In this case, the Partnership’s operating agreement provided that the limited partners could remove the general partner if they made a “good faith” determination that such removal was in the best interests of the Partnership.  The defendant general partner argued that, in addition to the contractual obligation to exercise their discretion in “good faith” when determining whether to remove the general partner, the limited partners were required to act reasonably under the implied covenant of good faith and fair dealing.  The Court rejected the defendant’s argument on the basis that the express contractual obligation to act “in good faith” superseded any obligation on the part of the limited partners to act in a particular manner under the implied covenant of good faith and fair dealing.  According to the Court, if the Partnership’s operating agreement had stated that the determination was to be made in the limited partners’ “sole discretion,” the effect would also have been to displace the implied covenant.

Document: Keyser v. Curtis, C.A. No. 7109-VCN (Del. Ch. July 31, 2012)

The Delaware Court of Chancery held invalid the creation and issuance of super-voting preferred stock by the sole director of Ark Financial Services, Inc. (“Ark”), an affiliate of Dawson James Securities, Inc. (“Dawson James”), because the director issued the stock to himself for nominal consideration and for the primary purpose of preventing Ark’s stockholders from electing a new board.

This action arose from a dispute over control of Ark by its founders: Robert D. Keyser (“Keyser”) and Albert Poliak (“Poliak”). In 2009, Keyser stepped down as CEO of Dawson James and as a director of its parent company, Ark, at the request of Ark’s creditors. Poliak became the sole director of Ark and also replaced Keyser as CEO of Dawson James. Subsequently, Keyser developed a plan to remove Poliak and elect himself and his allies to the Ark board by purchasing notes and an option to acquire a substantial portion of Ark’s common stock from Ark’s creditors. In response, Poliak created and issued himself a sufficient number of shares of a new series of super-voting, Series B preferred stock to dilute the stockholdings of Keyser and his allies below a majority of the outstanding voting power. After settlement negotiations failed, the Keyser faction purported to remove Poliak by an action by written consent of the holders of a majority of the outstanding common stock. Keyser and his allies then initiated an action pursuant to Section 225 of the General Corporation Law of the State of Delaware to determine the lawful directors of Ark.

In this post-trial decision, the Court determined that plaintiffs’ action by written consent was effective to remove Poliak as a director because the Series B preferred stock was void and plaintiffs’ consent therefore represented a majority of the outstanding voting power of Ark. In reaching the conclusion that the Series B preferred stock was void, the Court found that the issuance was the product of self-dealing. Poliak argued that the dilutive issuance was justified because Ark faltered under Keyser’s leadership and would suffer even greater financial distress if Keyser regained control of the company. The Court held that even if true, these facts failed to establish the entire fairness of Poliak’s decision to give control of the company to himself for nominal consideration and intentionally deprive Ark’s stockholders of the right to determine who should comprise the Ark board.

Document: Tang Capital Partners, LP v. Norton, C.A. No. 7476-VCG (Del. Ch. July 27, 2012)

The Delaware Court of Chancery held that a creditor could contractually waive its statutory right to bring an action for the appointment of a receiver under Section 291 of the General Corporation Law of the State of Delaware (“Section 291”).  Section 291 empowers the Delaware Court of Chancery to appoint a receiver for the administration of the affairs of an insolvent Delaware corporation upon the application of any stockholder or creditor of the corporation.  In this case, certain holders of senior convertible notes of Savient Pharmaceuticals, Inc. (“Savient”) sought, inter alia, the appointment of a receiver for Savient pursuant to Section 291 after Savient restructured some of its existing debt on terms that the plaintiffs claimed would be detrimental to Savient.  However, the terms of the indenture governing plaintiffs’ notes purported to preclude plaintiffs from seeking the appointment of a receiver for Savient unless, among other things, Savient defaulted on its loan.  Ruling on defendants’ motion to dismiss plaintiffs’ receivership action for lack of standing, the Court found that Savient had not defaulted on its debt obligations and that a contractual waiver or limitation of a statutory right to seek a receivership did not violate Delaware public policy, notwithstanding plaintiffs’ arguments to the contrary.

Document: In re Appraisal of The Orchard Enterprises, Inc., C.A. No. 5713-CS (Del. Ch. July 18, 2012)

The Delaware Court of Chancery rejected respondent’s argument that the value of the liquidation preference of its preferred stockholders should be deducted from respondent’s enterprise value when determining the value of the corporation’s common stock in an appraisal proceeding because the merger at issue did not constitute a liquidation event under respondent’s certificate of incorporation.

In July 2010, The Orchard Enterprises, Inc. (“Orchard”) effected a going-private merger with its controlling stockholder, Dimensional Associates, LLC (“Dimensional”). Orchard’s common stockholders were cashed out at a price of $2.05 per share.  The merger did not constitute a deemed liquidation entitling Orchard’s preferred stockholders to their liquidation preference under Orchard’s certificate of incorporation because it was a related party merger, and Orchard’s preferred stock remained outstanding at the effective time of the merger.  In this statutory appraisal action brought by holders of Orchard common stock, Orchard argued that the value of the preferred stockholders’ liquidation preference should be deducted from the enterprise value of Orchard when calculating the value of its common stock.  According to Orchard, Dimensional, as the holder of a majority of the outstanding preferred stock, could demand its liquidation preference as a precondition to any future merger with an unrelated party.  The Court found Orchard’s arguments unpersuasive because: (1) the issue of whether the liquidation preference may be triggered in the future was a matter of speculation as of the going-private merger date, and (2) under settled law, the petitioners were entitled to receive their pro rata share of the value of Orchard as a going concern—not its liquidation value.

On June 25, 2012, the Governor of the State of Delaware signed a bill into law that will make a number of amendments to the General Corporation Law of the State of Delaware (the “DGCL”) effective August 1, 2012. The amendments will enhance the administrative functioning of the Office of the Secretary of State of the State of Delaware (the “Secretary of State”).

Under amendments to Sections 254(d)(1), 263(c)(1) and 267(a) of the DGCL, a certificate of merger filed in connection with the merger of a Delaware corporation and a business entity formed under the laws of a jurisdiction other than Delaware will be required to identify the type of non-Delaware entity constituent to the merger. Similarly, certificates of conversion will be required to set forth the type of business entity which is converting into a Delaware corporation under amended Section 265 of the DGCL.

A number of provisions of the DGCL indirectly addressing Delaware registered agents also will be amended. All corporations incorporated in Delaware are required to have a registered agent in Delaware to accept service of process on behalf of the corporation. Certificates filed with the Secretary of State to revoke the filing of a certificate of dissolution will be required to identify the name and address of the corporation’s registered agent under amended Section 311 of the DGCL. The registered agent of a foreign corporation, which is qualified to do business in the State of Delaware, may be an individual or any type of entity under the amendments to Section 377 of the DGCL. Section 377 of the DGCL will be further amended by adding a new procedure for the reinstatement of a foreign corporation’s qualification to do business in Delaware which has lost such qualification for failure to appoint a registered agent. In addition, Section 390(b)(5) of the DGCL will be amended to clarify that the address for service of process provided by a domestic corporation in a certificate of transfer to a foreign jurisdiction may not be that of the corporation’s Delaware registered agent without the written consent of such registered agent.

Foreign corporations that are qualified to do business in the State of Delaware will be required to provide a certificate attesting to the surrender of their qualification to do business in Delaware should they decide to cease doing business in Delaware. Under current Section 381, a foreign corporation that dissolved in its jurisdiction of incorporation may surrender its authority to do business in the State of Delaware by filing with the Secretary of State the certificate of dissolution that was filed in the jurisdiction of incorporation without the filing of a certificate of withdrawal with the Secretary of State. Finally, Section 391 of the DGCL will be amended to clarify that the fees charged by the Secretary of State for filings under this section, such as certificates of incorporation and certificates of merger, are fees, not taxes.

With one exception, the amendments described above will become effective on August 1, 2012. The new procedures for the reinstatement of the qualification of a foreign corporation to do business in Delaware for failure to appoint a registered agent will become effective on August 1, 2013.