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Recent Delaware Corporate and Alternative Entity Decisions

In Re CNX Gas Corp. S’holder Litig., C.A. No. 5377-VCL (Del. Ch. July 5, 2010)

Controlling shareholders of CNX Gas Corporation sought to certify for interlocutory appeal a decision of the Chancery Court denying a preliminary injunction by a class of minority shareholders against a unilateral two-step freeze-out merger.  In the decision denying the preliminary injunction, the Court rejected the controlling shareholders’ position on the standard of review and held that the transaction would be reviewed for entire fairness under In re Cox Communications, Inc. Shareholders Litigation.  The application sought interlocutory appellate review to clarify the appropriate standard of review for a unilateral two-step freeze-out by a controlling shareholder.  The Chancery Court granted the application and found that review was warranted because attempts to apply Supreme Court precedent produced different conclusions regarding the appropriate standard for review, confusion regarding the inherent coercion in a two-step freeze-out merger, and conflict as to the degree to which a target board has a role in responding to a controller’s tender offer.  In addition, the court determined that the issue presented a question not directly addressed by the Supreme Court, implicated fundamental issues of Delaware public policy, and determined a substantial legal issue for purposes of Rule 42(b).   Update:  On July 8^th, the interlocutory appeal was denied by the Supreme Court of Delaware.

Morgan v. Cash, C.A. No. 5053-VCS (Del. Ch. July 16, 2010)

Morgan, a former common shareholder of Voyence, Inc., filed a claim against EMC Corporation, the acquirer of Voyence, for aiding and abetting alleged breaches of fiduciary duties by the former Voyence board.  Specifically, Morgan alleged that EMC used promises of continued employment and exploited conflicts of interest between the Voyence directors and common stockholders to gain Voyence management’s support for a low cash merger price.  Because none of the consideration from the sale was distributed to Voyence’s common shareholders, Morgan believed that EMC was complicit in the board’s failure to maximize stockholder value in the sale of the Voyence.  The Chancery Court granted EMC’s motion to dismiss the company from the shareholder litigation.  Vice Chancellor Strine determined that allegations of modest employment packages offered to two directors, standing alone, did not suggest that the Voyence board accepted a low merger price in exchange for improper personal benefits.  Additionally, the fact that Voyence directors received consideration from the sale of the corporation, and common shareholders did not, was not enough to sustain a claim of collusion between EMC and the Voyence directors.  Vice Chancellor Strine stressed that “[i]t is not a status crime under Delaware law to buy an entity for a price that does not result in a payment to the selling entity’s common stockholders.”

Milton Investments, LLC v. Lockwood Brothers II, LLC, C.A. No. 4909-VCP (Del. Ch. July 20, 2010)

Milton Investments and Lockwood Brothers were sole members of North Milton Development Group, LLC, and filed cross-motions for summary judgment to determine whether disputes between the Milton and Lockwood fell within the scope of the arbitration clause in North Milton’s LLC Agreement and whether the arbitrator designated in the Agreement was qualified to serve as arbitrator.  Milton claimed that the arbitration clause was narrow in scope and none of the issues that Lockwood sought to arbitrate were subject to arbitration.  Additionally, Milton claimed that the arbitrator identified in the Agreement was disqualified from serving based on conflicts of interest and statements made regarding the members and their dispute.  While the Chancery Court determined that the arbitration clause within the LLC Agreement was narrow in scope, each of the potentially arbitrable issues identified by the parties fit within the categories of disputes in the arbitration clause.  Vice Chancellor Parsons also held that the arbitrator could properly serve under the Agreement because the parties had selected him despite his known conflicts of interest.  Furthermore, the statements made by the arbitrator represented “initial thoughts and observations” and did not suggest that he would be incapable of evenhandedly considering the legal arguments in dispute.

TR Investors, LLC v. Genger, C.A. No. 3994-VCS (Del. Ch. July 23, 2010)

TR Investors, LLC and other capital investors of Trans-Resources, Inc. brought an action to have the Chancery Court determine control of the Trans-Resources board pursuant to 8 Del. C. § 225.  In 2004, Genger, the former founder and CEO of Trans-Resources, improperly transferred shares of Trans-Resources to trusts for his children in violation of a stockholders agreement with the capital investors.  After discovering the transfer in 2008, the capital investors reached an agreement with the Genger and the trusts to buy back all of the wrongfully transferred shares, giving the capital investors a majority of the Trans-Resources stock.  When the capital investors reconstituted the Trans-Resources board of directors, Genger challenged the reconstitution claiming that proper notice of the wrongful transfer was given in accordance with the stockholders agreement and that the capital investors nonetheless ratified the 2004 transfers when it acquired the shares in 2008.  The Chancery Court rejected the Genger’s claims and found that the capital investors controlled the Trans-Resources board.  Interpreting the stockholders agreement, the Court found that Genger had failed to comply with the notice requirement under the terms of the stockholders agreement.  Furthermore, Vice Chancellor Strine found the capital investors clearly reserved their position that the 2004 transfers were void and therefore did not ratify the transfers when it acquired the shares in 2008.  Accordingly, the capital investors retained the shares and control of the board.

Related Westpac LLC v. JER Snowmass LLC, C.A. No. 5001-VCS (Del. Ch. July 23, 2010)

JER Snowmass LLC, a funding member of two LLCs formed to pursue a land development project, filed a motion to dismiss a complaint filed by Related Westpac LLC, operating member of the project LLCs.  Related Westpac claimed that JER Snowmass breached its contractual duties under the project LLCs’ operating agreements by unreasonably refusing to give consent to various major decisions and meet calls for further capital funding of the development project.  The Chancery Court dismissed the complaint because the claims made by Related Westpac were inconsistent with the project LLCs’ operating agreements.  While JER Snowmass could not unreasonably withhold its consent to certain decisions under the operating agreements, the “material actions” involved in the complaint were not subject to such constraints.  JER Snowmass contractually bargained for the right to deny consent to material actions if it was in its own commercial self-interest.  The Court refused to impose a reasonableness condition with respect to material actions that the operating member had freely given up during formation of the operating agreement.  Furthermore, the Court would not imply a reasonableness requirement when it appeared in other sections of the operating agreement but not in the provision at issue.  The Chancery Court also dismissed Related Westpac’s request for damages and payment of capital calls because this remedy was in conflict with the plain terms outlined in the operating agreement.

2010 Amendments to Delaware Statutory Trust Act

Delaware Statutory Trust Act

A. Pools of Assets.  Amending § 3806(b)(2) of the Statutory Trust Act to:

• Confirm that pools of assets may constitute series.

B. Continuance of Statutory Trust in the Absence of a Trustee.  Amending § 3808(b) to:

• Confirm that a statutory trust will not be void for lack of a trustee.

C. Cancellation of a Certificate of Trust.  Amending § 3810(d) and § 3810(e) to clarify:

• The time of dissolution of a statutory trust that is not the surviving entity in a merger or consolidation or has transferred to another jurisdiction and/or converted to another entity.
• The effective time of a certificate of correction.
• The fact that the Secretary of State may not issue a certificate of good standing for a statutory trust once the certificate of trust has been cancelled.

D. Merger and Consolidation.  Amending § 3815 to:

• Provide increased flexibility with respect to amendment of an existing governing instrument or the adoption of a new governing instrument by, among other things, no longer requiring a specific reference to § 3815(f) of the Statutory Trust Act in the governing instrument agreement.  This amendment does not apply to statutory trusts formed prior to the effectiveness of this amendment unless the governing instrument of such statutory trusts provide otherwise.
• Clarify that a statutory trust that is not the surviving or resulting entity in a merger or consolidation is not considered to have dissolved and is not required to wind-up its affairs.
• Clarify that appraisal rights can be extended to series of beneficial interests.
• Add a new subsection (i) to §3815, which clarifies that a governing interest may provide that a statutory trust does not have the power to merge or consolidate.

E. Conversion of a Statutory Trust.  Amending § 3821 to:

• Add a new subsection (i) to §3821, which clarifies that a governing interest may provide that a statutory trust does not have the power to convert to another business entity.

F. Transfer or Continuance of a Statutory Trust.  Amending § 3823 to:

• Add a new subsection (h) to §3823, which clarifies that a governing interest may provide that a statutory trust does not have the power to transfer, domesticate or continue.

G. Construction and Application of Statutory Trust Act and Governing Instrument.  Amending § 3825 to:

• Add a new subsection (c) to § 3825, which clarifies that the doctrine of “independent legal significance” applies to statutory trusts.

H. Foreign Statutory Trusts.  Amending § 3852 to:

• Mandate that a foreign statutory trust registering with the Secretary of State must file a certificate, as of a date not earlier than 6 months prior to the filing date, issued by an authorized officer of the jurisdiction of its formation evidencing its existence, along with, if applicable, a translation thereof under oath.
• Require that a foreign statutory trust organized in series provide notice of that fact when registering with the Secretary of State and disclose whether there is a limitation on inter-series liability.

Recent Delaware Corporate and Alternative Entity Decisions

Lingo v. Lingo, No 713, 2009, Steele, J. (Del. Supr. June 10, 2010).

This Delaware Supreme Court opinion affirms the Court of Chancery’s judgment in ordering restitution from appellee daughter, and requiring her to return funds she misappropriated while acting as her mother’s attorney-in-fact, to the mother’s estate. In 2002, the mother created a new will that disinherited the son and named the daughter as the sole beneficiary and attorney-in-fact. As attorney-in-fact, the daughter took advantage of her mother’s diminished mental capacity and breached her fiduciary duties by engaging in self-dealing transactions. Due to the daughter’s breach, appellant son requested that: 1.) the daughter return all misappropriated funds to a testamentary trust established by the parents instead of the mother’s estate to which he was longer a beneficiary; and 2.) to have equitable forfeiture and a decrease of inheritance imposed on the daughter. In refusing to impose the requested remedy, the Supreme Court noted, “Delaware courts have long recognized that restitution is the appropriate remedy . . . to redress a breach of fiduciary duty where a part is unjustly enriched at the expense of another.” Further, because the son was disinherited, imposing equitable forfeiture against the daughter would conflict with the mother’s clearly expressed testamentary intent.

Gentile v. Rossette, C.A. No. 20213-VCN, Noble, V.C.  (Del. Ch. May 28, 2010).

Plaintiffs, former minority shareholders (“FMS”) of SinglePoint Financial, Inc. (“SinglePoint”) alleged that the defendants, majority shareholder and director, P. David Rossette (“Rossette”), and director Douglas W. Bachelor (“Bachelor”) breached their fiduciary duties by approving a debt conversion transaction (“Debt Conversion”) which improperly diluted the FMS’ voting and economic rights. The Court found that the entire fairness standard applied to the Debt Conversion because, “Rossette was able to orchestrate the pricing component for his benefit . . . a classic example of self-dealing by a controlling stockholder.” Consequently, the court held that both the process and price of the Debt Conversion was unfair, noting that “Rossette set the conversion with limited or no pushback from Bachelor, who was in no position to bargain effectively on behalf of the minority stockholders.” As for the price, the Court relied most notably on “Rosette’s persistent willingness . . . to pour his ultimately limited resources into the Company,” in concluding that SinglePoint’s stock was worth considerably more than the $ 0.05 per share Rossette determined. Accordingly, the Court awarded damages equal to the difference between what the Court found as the fair value of the shares ($ 0.40) and the $ 0.05 conversion rate. Further, the Court held that Bachelor was entitled to the protection of SinglePoint’s exculpatory provision adopted under 8 Del. C. s 102(b)(7) because despite approving of the Debt Conversion, he had not acted disloyally and his conduct was not in bad faith

Fletcher International, Ltd. v. ION Geophysical Corp., C.A. No. 5109-VCP, Parsons, V.C. (Del. Ch. May 28, 2010).

Fletcher, the owner of all outstanding Series D Preferred Stock at ION Geophysical Corp. (“ION”), filed a motion for partial summary judgment with regard to ION’s issuance of a convertible promissory note through a subsidiary.  Plaintiff claimed that the issuance of this note without his permission violated the terms under the Certificate of Rights and Preferences which stipulated that he had a right to consent to issuances of a security by a subsidiary.  Fletcher also claimed that Director Defendants breached their fiduciary duty of loyalty by failing to disclose all material facts concerning the note and provide a timely and meaningful vote on its issuance.  In its decision, the Court found that the note issued by ION was indeed a security under the Certificate and that the issuance of the note without Fletcher’s consent violated his contractual rights.  The Court, however, dismissed the breach of fiduciary duty claim because it was based on a contract violation that could be remedied through the breach of contract claim.  In reaching this conclusion, the court noted that unless fiduciary duty claims are “based on duties and rights not provided for by contract, a plaintiff cannot maintain both contractual and fiduciary duty claims arising out of the same alleged wrongdoing.”

Baca v. Insight Enter., C.A. No. 5105-VCL, Laster, V.C. (Del. Ch. June 3, 2010).

Baca, a shareholder of Insight Enterprises Inc. (“Insight”), brought action in Delaware Chancery Court after Insight rejected his requests to inspect books and records of the company pursuant to Section 220.  Months prior to the request, Baca filed a derivative action in Federal Court seeking damages for harms resulting from misstatements made in the financial reports of Insight.  The Court found that he could not establish a proper purpose for his Section 220 demand.  Citing King v. Verifone Holding, Inc., the Court noted that a stockholder does not act with a proper purpose when he or she uses Section 220 to investigate matters already at issue in a plenary derivative action.  Because Baca filed a derivative action before the Section 220 request, and the request covered matters at issue in the derivative action, he did not have a proper purpose for seeking books and records.

Cambridge North Point LLC v. Boston and Maine Corp., C.A. No. 3451-VCS, Strine, V.C. (Del. Ch. June 17, 2010).

This case involved the enforceability of a settlement agreement between Boston and Maine Corporation (“B&M”) and Cambridge North Point (“Cambridge”).  B&M claimed that the settlement agreement was unenforceable based on theories of misrepresentation and unilateral mistake.  Specifically, Defendants argued that Cambridge quietly revised the settlement agreement between drafts and Defendants signed the agreement believing different terms had been memorialized.  The court ultimately rejected B&M’s claims and required the agreement be enforced in full.  Specifically, the Court found that Cambridge did not make any misrepresentations due to the fact that the revisions that Cambridge offered were clearly available for B&M to read and examine.  Additionally, B&M failed to produce evidence showing that Cambridge knew or should have known that B&M was mistaken and the Court noted that both each side had lawyers participating in negotiations and the various iterations of the draft settlement were in available for review.  As a result, the Court mandated that B&M pay $3.5 million as stipulated in the settlement agreement, fulfill additional obligations under the contract, and pay damages for certain breaches of the agreement.

New Article by Ellisa Habbart and Thomas Rutlege Posted

“The Uniform Statutory Trust Entity Act: A Review”

By: Thomas E. Rutlege and Ellisa Opstbaum Habbart

Abstract:

The Uniform Statutory Trust Entity Act, the most recent product of the National Conference of Commissioners on Uniform State Laws in the area of business entity legislation, is intended to render uniform the statutory (i.e., “business”) trust across the various states. Currently, business trust legislation is widely disparate across the various states, and many of the existing statutes are at best skeletal. This Act has the objective of rendering the business trust more effective as a form of organization by addressing many issues that are typically seen in other business entity laws, while at the same time seeking to minimize both unexpected and, in certain places, undesirable results otherwise dictated by applicable trust law. This Article both reviews the workings of this new uniform act and identifies issues and deficiencies therein.

Click here to view the full article in PDF format.

Overview of Significant 2010 Del. Corporate Law Amendments

I. LLC Act, DRULPA and DRUPA

A. Inapplicability of Statute of Frauds. Amending § 18-101(7) of the LLC Act, §17-101(12) of DRULPA and §15-101(12) of DRUPA to:
• Explicitly provide that limited liability company agreements, limited partnership agreements and partnership agreements are not subject to any statute of frauds in light of the Delaware Supreme Court’s decision in Olson v. Halvorsen, C.A. No. 1884 (Del. Dec. 15, 2009).

B. Irrevocable Power of Attorney. Amending § 18-106(d) and § 18-204(c) of the LLC Act, § 17-106(d) and 17-204(c) of DRULPA and § 15-123 and §15-202(f) of DRUPA to:
• Explicitly provide that limited liability companies, limited partnerships and general partnerships generally have the authority to grant, hold or exercise a power of attorney, including an irrevocable power of attorney as well as powers of attorney relating to the organization, internal affairs or termination of such entities, unless the applicable governing documents provide otherwise.

C. Electronic Service of Process. Amending several statutory provisions, including § 18-105(b) of the LLC Act, § 17-204(c) of DRULPA and § 15-112(b) of DRUPA to:
• Add language indicating that in circumstances where service of legal process against the entity is permitted by the applicable statute, process may be served upon the Secretary of State by means of electronic transmission, but only as prescribed by the Secretary of State. Similar changes were also made to several sections of the DGCL and the Statutory Trust Act.

D. Short Form Mergers with Delaware Corporations. Amending various provisions of the LLC Act, DRULPA and DRUPA to:
• Add language making these statutes compatible with new § 267 of the DGCL, which permits non-corporate parent entity to effect a short-form merger with a Delaware corporation as described below.

E. Information Demands. Amending § 18-305(f) of the LLC Act, § 17-305(e) of DRULPA and § 15-403 of DRUPA to:
• Clarify that the time period for responding to an information demand may be varied by a limited liability company/partnership agreement, but may not be made longer than 30 days.

F. Foreign Limited Liability Companies and Partnerships: Amending §18-902 of the LLC Act, § 17-902 of DRULPA and § 15-1102(a) of DRUPA to:
• Require that foreign limited liability companies, limited partnerships and partnerships registering with the Secretary of State must file a certificate, as of a date not earlier than 6 months prior to the filing date, issued by an authorized officer of the jurisdiction of its formation evidencing its existence, along with, if applicable, a translation thereof under oath.

G. Assignment of Interests: Amending § 18-702(a) of the LLC Act and § 17-704(a) of DRULPA to:
• Confirm the circumstances in which an assignee of a limited liability company/partnership interest may participate in the management of the business and affairs of a limited liability company/become a limited partner of a limited partnership.

II. DGCL Provisions addressing nonstock corporations.

A. Although the DGCL already contained many provisions that differentiated between corporations authorized to issue capital stock and corporations not authorized to issue stock (nonstock corporations), there were many significant issues involving nonstock corporations that were not adequately addressed by the statue. This comprehensive series of amendments has filled in the gaps by creating a new “translator” provision (Section 114) that provides guidance as to which provisions of the DGCL apply to nonstock corporations generally, which provisions contain special provisions that apply only to non-stock corporations, and which provisions are expressly inapplicable to nonstock corporations, and also amends many other provisions of the DGCL in order to create a cohesive statutory scheme for governing nonstock corporations.

B. While most of the nonstock amendments do not make significant substantive changes to the law, several changes are noteworthy, including the following:
• The DGCL now expressly requires that all nonstock corporations have members, although the failure to comply with this requirement shall not result in the corporation being invalidated. If a nonstock corporation has not set forth the conditions for membership in its certificate of incorporation or bylaws, its members are deemed to be those who voted for the members of the corporation’s governing body.
• The DGCL now specifically defines a “charitable nonstock corporation” as “any non-profit nonstock corporation that is exempt from taxation under § 501(c)(3) of the United States Internal Revenue Code or any successor provisions” and contains several provisions prohibiting the taxing of certain otherwise permissible corporate actions (i.e. mergers and entity conversions) where doing so would cause the entity to no longer qualify for § 501(c)(3) exempt status.
• By clarifying the procedures for setting record dates, the calling of special meetings of members and the required vote that must be obtained, the DGCL now makes it easier for nonstock corporations to effect mergers (including short-form mergers with subsidiary corporations) and address other corporate governance matters.
• Finally, there are several provisions which provide for disparate treatment for nonstock non-profit corporations, as opposed to nonstock corporations that may be for-profit entities. One example of this dichotomy is an express provision that makes § 144(a)(2) inapplicable to nonstock non-profit corporations in order to comply with the Delaware Supreme Court’s holding in Oberly v. Kirby, 592 A.2d 445, 467-68 (Del. 1991) that members of a non-profit nonstock corporation may not ratify interested transactions because they have no financial interest in the corporation.

IV. Other Significant Amendments to the DGCL:

A. Short-Form Mergers with Non-Corporate Entities. Adding a new Section 267 and making corresponding changes to other sections of the DGCL to:
• Provide a mechanism for a short-form merger of a Delaware corporation with a non-corporate parent entity where the parent entity owns 90% or more of the outstanding stock of the corporation. As noted above, amendments have also been made to the alternative entity statutes in order to make those statutes compatible with the new Section 267.

B. Indemnification and Advancement. § 145 (d) and (e) are being amended to:
• Clarify that the requirement that indemnification decisions be made by certain specified decision making bodies and the statutory procedural requirements and prerequisites associated with advancement of expenses only apply when the potential indemnitee/recipient of advanced funds is serving as a director or officer of the corporation, but do not apply in connection with a person serving at the request of the corporation as a director or officer of another corporation or alternative entity.

C. Amendment and Restatement of Certificate of Incorporation in Connection with Merger. Minor additions to §§ 251, 252, 254, 263 and 264 are being made in order to:
• Expressly provide that in a merger, the certificate of incorporation of a surviving corporation may be amended and restated in its entirety.

D. Dissolution of time-limited corporations. § 278 is being amended to:
• Clarify that the dissolution procedures set forth in the DGCL must be adhered to notwithstanding the fact that a corporation’s (including special purpose acquisition companies) certificate of incorporation contains a provision indicating that the corporation expires after a specified term.

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