Updates
The Delaware Counsel Group LLP publishes legal updates regarding critical areas of Delaware Corporate and Alternative Business Entity Law on a bi-weekly basis. If you would like to sign up to receive our updates via email or post, please click here to subscribe.Recent Corporate and Alternative Entity Decisions From the Delaware Courts
Posted : April 30th, 2012Chancery Court Denies Defendants’ Motion To Dismiss Revlon Claims
In In re Answers Corp. S’holder Litig., C.A. No. 6170-VCN (Del. Ch. Apr. 11, 2012), the Delaware Court of Chancery declined to dismiss a complaint alleging that the directors of Answers Corporation (“Answers”) breached their fiduciary duties under Revlon in connection with the acquisition of Answers by an affiliate of the private equity firm Summit Partners L.P. (“Summit”), on the basis that a majority of the members of Answers’ board were either interested in the merger or had acted in bad faith in approving the merger. Prior to the merger, Answers’ President and CEO, Robert Rosenschein, held one board seat, and Redpoint Ventures (“Redpoint”), Answers’ largest stockholder, controlled two seats. The remaining five seats on the board were held by unaffiliated directors.
Plaintiffs alleged that Answers’ board approved the merger at an inadequate price and using an inadequate process to accommodate Redpoint’s desire for liquidity. Answers’ stock was thinly traded which made it difficult for Redpoint to sell its 30% interest absent a sale of the entire company. According to the plaintiffs, Redpoint threated to replace Answers’ entire management team, including Rosenschein, if Answers was not sold quickly. Redpoint facilitated a meeting with Summit in March 2010, and Answers focused its sales efforts almost solely on Summit, with the exception of a two-week market check period that coincided with the December holidays. Plaintiffs argued that the market check was wholly inadequate because, inter alia, Answers’ financial and operating performance had steadily been improving since the time of Summit’s initial bid, but those results had not yet been disclosed publicly. In other words, the market and potential bidders did not have a complete picture of the company’s financial position.
The Court found that the plaintiffs had stated a claim for breach of the duty of loyalty as applied in a transaction implicating Revlon. Specifically, the complaint alleged that: (1) Rosenschein was interested in the merger because he would lose his job if a sale were not consummated; (2) the Redpoint directors were interested in the merger because the merger furthered their employer’s need for liquidity; and (3) the remaining members of the board approved the sales process in bad faith because they knew that Summit’s offer undervalued the company.
Court of Chancery Upholds Contractual Modification of Fiduciary Duties in Limited Partnership Context
In In re K-Sea Transportation Partners L.P. Unitholders Litig., C.A. No. 6301-VCP (Del. Ch. Apr. 4, 2012), the Delaware Court of Chancery dismissed claims that, inter alia, the general partner of a publicly-traded Delaware limited partnership, K-Sea Transportation Partners L.P. (“K-Sea”), and the general partner’s directors breached their fiduciary duties in approving a merger of K-Sea with an unaffiliated third party in which the general partner received a separate payment for certain partnership units it held exclusively. The Court found that K-Sea’s limited partnership agreement effectively eliminated the fiduciary duties of the general partner and its directors, with the exception of the duty to act in good faith. Further, the Court upheld a provision in the limited partnership agreement creating a conclusive presumption of good faith for decisions made by the general partner and its directors in reliance on expert opinions. Here, the general partner and its directors relied on a fairness opinion obtained by the general partner’s conflicts committee. Finally, the Court held that the plaintiffs could not state a claim for breach of the implied covenant of good faith and fair dealing where the defendants acted in a manner that ensured that they were entitled to a conclusive contractual presumption of good faith.
Chancery Court Finds Multiple Stockholders Collectively Constitute a Controlling Stockholder in Two Recent Decisions
I. Zimmerman v. Crothall
In Zimmerman v. Katherine D. Crothall et al., C.A. No. 6001-VCP (Del. Ch. Mar. 27, 2012), the Delaware Court of Chancery found that certain commonalities often shared by venture capital investors supported a reasonable inference that two venture capital investors in Adhezion Biomedical LLC (“Adhezion”) were a controlling stockholder group. As a result, the transactions at issue in which the investors received additional interests in Adhezion were held to be subject to entire fairness review.
Adhezion is an early-stage medical products company with two principal venture capital investors who hold preferred units: Liberty Ventures II, L.P. (“Liberty”) and Originate Ventures, LLC (“Originate” and, together with Liberty, the “VC Investors”). The VC Investors jointly possess more than 66% of Adhezion’s voting power and their representatives hold two of five seats on Adhezion’s board. Plaintiff, a co-founder and former CEO of Adhezion, alleged that Adhezion’s directors (aided and abetted by the VC Investors) breached their fiduciary duties of care and loyalty in approving a number of transactions in which the VC Investors made additional investments in the cash-strapped company on terms not offered to Adhezion’s common unitholders. The defendants moved for summary judgment on all counts.
The Court commenced by finding that plaintiff had failed to meet his burden of pleading with respect to the duty of care claims – i.e., the evidence did not show that the Adhezion board acted irrationally or recklessly in its capital raising efforts. The board contacted over 40 potential investors in a seven-month period and considered a range of funding options, including licensing deals and the sale of the entire company, before it approved the challenged transactions with the VC Investors.
However, the Court denied defendants’ motion for summary judgment on plaintiff’s duty of loyalty claims. Specifically, the Court found that the defendants had approved self-dealing transactions in which a controlling stockholder received additional equity interests in the company on terms that were not available to the common unitholders. In reaching the conclusion that the VC Investors jointly constituted a controlling stockholder, the Court focused on the fact that Originate and Liberty were Adhezion’s two largest investors, had invested in Adhezion at around the same time and each had one designee on the board. Further, the Court looked to e-mails and board minutes in which the VC Investors communicated similar concerns and solutions with respect to Adhezion’s capital raising efforts as evidence that they were acting in concert with respect to, and exercising actual control over, such efforts.
The Court also found that the challenged transaction constituted an interested transaction because a majority of the members of the board participated in the financings at issue. Accordingly, at trial, defendants would have to prove that the challenged transactions met the exacting entire fairness standard.
II. Frank v. Elgamal
In Frank v. Elgamal et al., C.A. No. 6120-VCN (Del. Ch. Mar. 30, 2012), the Delaware Court of Chancery held that four officers (the “Control Group”) of defendant American Surgical Holdings, Inc. (“American Surgical”) collectively constituted a “controlling stockholder” in connection with American Surgical’s acquisition by a private equity fund because each member of the Control Group (which collectively held 71% of American Surgical’s voting power) agreed to vote in favor of the merger and accepted employment with, and an interest in, the surviving entity.
In December 2010, American Surgical entered into a merger agreement with Green Point Partners, I LP (“Green Point”). As in many private equity transactions, Green Point used lucrative employment agreements and equity interests in the surviving entity to incentivize key American Surgical officers (the Control Group) to stay on following the consummation of the merger. In return, the members of the Control Group agreed to vote in favor of the merger. Plaintiff alleged, inter alia, that the board and the members of the Control Group breached their fiduciary duties in approving/negotiating a merger in which insiders received a benefit not shared equally with the corporation’s remaining stockholders. Defendants moved to dismiss the complaint, inter alia, on the grounds that the plaintiff had not rebutted the business judgment presumption.
The Court disagreed with the defendants. Specifically, the Court found that (1) the Control Group constituted a controlling stockholder for the reasons identified above; and (2) mergers between a controlled corporation and an unaffiliated third party in which the controller receives an interest in the surviving entity and the minority stockholders are cashed out are subject to entire fairness review absent robust procedural protections. While the merger had been negotiated by a special committee of independent and disinterested directors, the transaction had not been subject to a majority of the minority vote. According to the Court, the procedural protections of a special committee and a majority of the minority vote are required to avoid entire fairness review.
Chancery Court Declines to Remove Sitting Director Prior to the Adjudication of Claims Against Him
In Shocking Technologies, Inc. v. Michael, C.A. No. 7164-VCN (Del. Ch. Mar. 26, 2012), the Delaware Court of Chancery dismissed a claim brought by Shocking Technologies, Inc. (“Shocking”) against one of its directors seeking the director’s removal from Shocking’s board of directors by the Court prior to an adjudication of liability for breach of the fiduciary duty of loyalty. Under Section 225(c) of the Delaware General Corporation Law (“Section 225(c)”), the Delaware Court of Chancery is empowered to remove a director of a corporation if such director has been found by “prior judgment on the merits” to have breached his fiduciary duty of loyalty. Plaintiff argued, and the Court did not completely reject the proposition, that the Court had the inherent equitable power to remove a director for a breach of fiduciary duty in an action not brought in accordance with Section 225(c). However, the Court found that the action before it was not so unusual or pressing that it would be inclined to exercise any inherent equitable powers (if they existed) to remove a sitting director who had not been adjudicated liable of any wrongdoing. The Court also noted in a footnote that there was significant authority for the proposition that it not have the power to remove a sitting director other than as granted by statute.
Recent Corporate and Alternative Entity Decisions From the Delaware Courts
Posted : April 5th, 2012Chancery Court Finds Board’s Decision to Give Controller Disparate Merger Consideration Likely Violates Fiduciary Duties.
In In re Delphi Fin. Group S’holders Litig., C.A. No. 7144-VCG (Del. Ch. Mar. 6, 2012), the Delaware Court of Chancery found that plaintiffs had established a reasonable likelihood of success on the merits of their claims that Robert Rosenkranz (“Rosenkranz”), the controlling stockholder and founder of Delphi Financial Group (“Delphi”), breached his fiduciary duties in extracting more merger consideration for himself than for Delphi’s minority stockholders in connection with a proposed acquisition of Delphi by Tokio Marine Holdings, Inc. (“TMH”). However, the Court declined to grant plaintiffs’ request to enjoin the merger because Delphi’s minority stockholders would receive a substantial premium for their shares, no other potential purchaser had emerged, and money damages would be an available and adequate remedy.
Delphi had a dual-class structure: (1) Class A stock, held largely by public stockholders, and (2) Class B stock, held by Rosenkranz. Delphi’s certificate of incorporation required equal treatment of the Class A and Class B stock in a merger. However, Rosenkranz would not agree to any merger unless he received a control premium. As a result, the merger with Delphi was conditioned on a charter amendment being approved by stockholders that removed the equal treatment requirement. The merger was also conditioned on a vote of a majority of the minority stockholders; however, the Court found that the vote would be potentially coerced given Rosenkranz’s demand for a price differential. Although a controlling stockholder is entitled to negotiate for a control premium, the prohibition in Delphi’s post-IPO certificate of incorporation on disparate merger consideration presumably reflected that Rosenkranz had already received a control premium in connection with the sale of the Class A shares.
Accordingly, having found that the plaintiffs had established a reasonable likelihood of success on the merits of their claims, the Court turned to the issues of irreparable harm and the balance of the equities. Finding that the holders of Class A stock might suffer irreparable harm if an injunction were issued because they would lose a 76% premium, the Court denied the request for injunctive relief.
Delaware Supreme Court Affirms Superior Court Decision Interpreting Preferred Stock.
In Alta Berkeley VI C.V. v. Omneon, Inc., C.A. No. 442, 2011 (Del. Mar. 5, 2012), the Delaware Supreme Court upheld the Delaware Superior Court’s decision to reject plaintiffs’ claim that they were entitled to receive their liquidation preference as holders of Series C preferred stock of Omneon, Inc. (“Omneon”) in connection with Omneon’s acquisition by Harmonix, Inc. (“Harmonix”). Plaintiffs’ Series C preferred stock had been converted into common stock the day before the merger under a forced conversation provision. In the merger, the plaintiffs received the consideration payable to holders of common stock, which was less than their liquidation preference. Plaintiffs argued that they were entitled to their liquidation preference because the conversion of their shares of Series C preferred stock into common stock was part and parcel of the merger, a “Liquidation Event,” under Omneon’s certificate of incorporation. The Superior Court disagreed.
On appeal, the Delaware Supreme Court upheld the Superior Court’s ruling for the following reasons. A “Liquidation Event” was defined by Omneon’s certificate of incorporation to include an acquisition of Omneon by any person or entity “by means of any transaction or series of related transactions” in which Omneon’s stockholders immediately prior to the transaction owned less than 50% of Omneon after the transaction. According to the Court, plaintiffs’ interpretation was unreasonable because Harmonic played no role and received no voting power in the conversion.
Chancery Court Finds Goldman Sachs and El Paso’s CEO Likely Tainted Merger Process.
In In re El Paso Corp. S’holder Litig., C.A. No. 6949-CS (Del. Ch. Feb. 29, 2012), the Delaware Court of Chancery found that plaintiffs were reasonably likely to succeed on the merits of their claims that the CEO of El Paso corporation (“El Paso”) and El Paso’s directors breached their fiduciary duties under Revlon in approving an acquisition of the company by Kinder Morgan, Inc. (“Kinder Morgan”) where El Paso’s two principal negotiators had interests inimical to the interests of El Paso’s stockholders. Specifically, El Paso’s CEO had secretly made a bid to acquire a part of El Paso’s business from Kinder Morgan if Kinder Morgan acquired the entire company as planned. In addition, El Paso’s investment banker, Goldman Sachs, owned 14% of Kinder Morgan. Furthermore, the lead Goldman Sachs banker advising El Paso owned approximately $340,000 in Kinder Morgan stock, a fact which he failed to disclose during negotiations. While Goldman Sachs brought in Morgan Stanley to issue the fairness opinion, if appropriate, Morgan Stanley would not be paid unless it found the transaction to be fair.
The Court found that it was difficult to conclude that the board’s less than aggressive negotiating tactics, failure to conduct a pre-signing market check and agreement to aggressive deal protection measures were not related to the conflicts of El Paso’s key negotiators described above. However, the Court declined plaintiffs’ request for injunctive relief because no alternative bidder had emerged, and El Paso’s stockholders were well-positioned to vote against the merger should they decide that the merger price was inadequate.
Chancery Court Rejects Disclosure and Revlon Claims.
In In re Micromet, Inc. S’holders Litig., C.A. No. 7197-VCP (Del. Ch. Feb. 29, 2012), the Delaware Court of Chancery found that plaintiffs had not shown a reasonable likelihood of success on the merits of their claims that the directors of Micromet, Inc. (“Micromet”) breached their fiduciary duties under Revlon in agreeing to be acquired by Amgen, Inc. (“Amgen”) in an all-cash, negotiated tender offer. Accordingly, the Court denied plaintiffs’ request for a preliminary injunction.
Micromet, an early stage pharmaceutical research and development company, received an initial bid of $9.00 per share from Amgen in July 2011, which the Micromet board deemed inadequate. Amgen continued to court Micromet over the next five months with offers that Micromet rejected, while Micromet pursued strategic partnerships. In January 2012, Amgen increased its offer price to $11.00 per share, and the Micromet board authorized Goldman Sachs, its banker, to conduct a market check. None of the companies contacted by Goldman Sachs made an offer, and Micromet and Amgen entered into a definitive agreement.
Plaintiffs alleged that Micromet’s sales process was wholly deficient under Revlon. First, plaintiffs challenged the board’s decision to eschew private equity buyers. According to the Court, the board acted reasonably in focusing on large pharmaceutical companies that would have both the capital and technical expertise necessary to commercialize and distribute Micromet’s technologies. Plaintiffs also alleged that the market check was deficient because potential buyers had been given only a week to conduct due diligence. However, six of the seven potential buyers had conducted limited due diligence on Micromet during its partnering process. Given the prior access and the fact that Amgen only had access to due diligence materials over a two-week period, the Court held that the Micromet board acted reasonably.
The Court also rejected all of plaintiffs’ disclosure claims. The claims rejected by the Court included a claim that Micromet was required to disclose management’s “upside case” projections. The projections were not relied upon by Goldman Sachs, and Micromet’s management testified that the projections were not reliable.
Chancery Court Enjoins Asset Sale Because It Would Likely Breach Indenture.
In In re BankAtlantic Bancorp, Inc. Litig., C.A. No. 7068-VCL (Del. Ch. Feb. 27, 2012), the Delaware Court of Chancery enjoined defendant BankAtlantic Bancorp, Inc., a bank holding company (“Bancorp”), from consummating a sale of its only substantial asset, BankAtlantic, a federal savings bank (“BankAtlantic”), on the basis that the sale would violate eight substantially identical indentures governing Bancorp’s debt securities. Specifically, each indenture prohibited Bancorp from selling all or substantially all of its assets unless the purchaser assumed Bancorp’s obligations under the indenture. Bancorp had entered into an agreement for the sale of its stock (the “Sale”) in BankAtlantic to BB&T Corporation (“BB&T”), and it was undisputed that BB&T was not assuming Bancorp’s obligations under the indentures. In determining whether the Sale would constitute a sale of all or substantially all of Bancorp’s assets, the Court analyzed the effects of the Sale on both a quantitative and qualitative basis as it was required to, under New York law, which governed all but one of the indentures. On a quantitative basis, the Court looked at book value and found that BankAtlantic constituted 85-90% of Bancorp’s book value. In so finding, the Court rejected defendant’s argument that the value of the consideration that Bancorp was receiving from BB&T for BankAtlantic’s stock should be subtracted from the numerator when calculating the percentage of Bancorp’s book value represented by BankAtlantic. On a qualitative basis, the Court found that the Sale would constitute a watershed event. Following consummation of the Sale, Bancorp would exit the banking business and lose its status as a federally regulated bank holding company. Accordingly, after finding that plaintiffs would suffer irreparable harm if the Sale were not enjoined and that the balance of the equities favored an injunction, the Court enjoined the Sale.
Recent Corporate and Alternative Entity Decisions From the Delaware Courts
Posted : March 8th, 2012Chancery Court Dissolves A Public Company.
In Williams v. Calypso Wireless, Inc., C.A. No. 7140-VCL (Del. Ch. Feb. 8, 2012), the Delaware Court of Chancery took the extraordinary step of appointing a receiver to dissolve a publicly traded corporation that was essentially defunct, under Section 322 of the Delaware General Corporation Law (the “DGCL”), which by its terms allows the Court of Chancery to appoint a receiver where a corporation fails to follow a court order. In this case, Calypso Wireless, Inc. (“Calypso”) had failed to hold an annual meeting since 2002 despite being ordered to hold a meeting in 2008. While the plaintiff in this action merely sought the appointment of a receiver to hold a meeting of stockholders, the Court ordered Calypso to be dissolved because of its flagrant violation of Delaware law and apparent violation of federal securities laws. Calypso had not filed an annual report on Form 10K in nearly four years, had no income or revenues and was likely insolvent on a balance sheet basis. Accordingly, the Court determined that there was no realistic possibility that Calypso could comply with the meeting order even under the direction of a receiver. However, the Court proceeded with the appointment of a receiver solely in order to dissolve the company.
Chancery Court Interprets Mandatory Indemnification Provisions.
In Hermelin v. K-V Pharmaceutical Co., C.A. No. 6936-VCG (Del. Ch. Feb. 7, 2012), the Delaware Court of Chancery considered, inter alia, whether a former corporate officer was entitled to be indemnified for expenses under Section 145(c) of the DGCL on the basis that he had been “successful on the merits or otherwise” in defending three proceedings. The proceedings all stemmed from investigations relating to the manufacture of defective prescription drugs by the plaintiff’s former employer, defendant K-V Pharmaceutical Company (“KV”). The Court rejected plaintiff’s claim that he was “successful” in a criminal proceeding because he pled guilty to every charge against him, paid a substantial fine and served time. The Court also rejected plaintiff’s argument that he was entitled to be indemnified for expenses incurred in defending a proceeding brought by the Department of Health and Human Services (“HHS”). Because HHS banned plaintiff for twenty years (but could have imposed a lifetime ban and fines), plaintiff argued that the twenty year ban was a successful outcome under Section 145(c). The Court found that a twenty year ban was not a success. However, the Court found that plaintiff was entitled to be indemnified for expenses incurred in defending an investigation brought by the Food and Drug Administration (the “FDA”). As a result of the FDA investigation, KV entered into a consent decree with the FDA pursuant to which KV and its affiliates agreed not to manufacture any drugs until their operations were in compliance with federal standards. The consent decree did not apply to plaintiff unless he was rehired by KV. Because plaintiff avoided a personally negative result, the Court found he was entitled to be indemnified.
Chancery Court Confirms Default Fiduciary Duty Rule for LLCs.
In Auriga Capital Corp. v. Gatz Properties, LLC, C.A. No. 4390-CS (Del. Ch. Jan. 27, 2012), the Delaware Court of Chancery held that the manager and majority owner of a limited liability company (the “LLC”) breached his fiduciary duties by allowing the LLC’s most valuable asset to depreciate in value and then forcing the minority holders to sell their LLC interests to him for a fraction of their value. The Court also confirmed that absent a provision in the limited liability company agreement to the contrary, the managers of Delaware limited liability companies owe fiduciary duties of care and loyalty to the members of the limited liability company. In this case, the limited liability company did not alter the manager’s fiduciary duties, and the Court ordered the defendant manager and majority owner to pay the minority holders $776,515 in damages.
Chancery Court Addresses Appraisal of Preferred Stock.
In Shiftan et al. v. Morgan Joseph Holdings, Inc., C.A. No. 6424-CS (Del. Ch. Jan. 13, 2012), the Delaware Court of Chancery granted summary judgment in favor of petitioners on the issue of whether a mandatory redemption provision, which provided for an automatic redemption of preferred stock six months following a merger giving rise to appraisal rights, was required to be taken into account in the Court’s determination of the “fair value” of the preferred stock. Unlike common stock, the value of preferred stock in an appraisal proceeding is determined solely by reference to the contract rights conferred upon it in the certificate of incorporation. Here, the preferred stock would have been redeemed for $100 per share, just six months after the merger giving rise to appraisal rights, pursuant to a specific, non-speculative, contractual right, which the Court determined was an important economic factor bearing on the value of the preferred stock as of the date of the merger.
Plaintiff Trades on Information Received in Litigation Discovery.
In Steinhardt v. Occam Networks, Inc., C.A. No. 5878-VCL (Del. Ch. Jan. 6, 2012), the Delaware Court of Chancery dismissed plaintiff as a class representative and ordered him to disgorge more than $500,000 in illicit profits gained from trading on insider information obtained in the course of the class action proceedings. Plaintiff was a representative plaintiff in this action which challenged the merger of Occam Networks, Inc (“Occam”) with and into Calix, Inc. (“Calix”). Plaintiff, a stockholder of Occam, alleged that the merger price was too low and that Occam’s directors breached their fiduciary duties in approving the merger. After litigation discovery commenced, plaintiff became privy to confidential information, which lead him to believe that Occam had been overvalued and that the merger price was unlikely to change as a result of the litigation. Based on this information, plaintiff then began selling Calix shares short to exit his Occam position. By selling Calix short, plaintiff could both liquidate his Occam position and take advantage of the arbitrage spread that existed between Calix and Occam stock at the time. Consistent with prior rulings, the Court ordered plaintiff to disgorge his illicit profits.
Chancery Court Holds Modified Fiduciary Duties in Limited Partnership Context Still Require Good Faith Exercise of Discretion by Management.
In Gerber v. Enterprise Products Holdings, LLC, et al., C.A. No. 5989-VCN (Del. Ch. Jan. 6, 2012), the Delaware Court of Chancery granted defendants’ motion to dismiss fiduciary and tort claims arising from the sale by Enterprise GP Holdings, L.P. (“EPE”) of its interest in a subsidiary to an affiliate and the subsequent merger of EPE into a wholly-owned subsidiary of such affiliate. EPE’s partnership agreement provided that EPE’s general partner would not breach any fiduciary duty by entering into a transaction, in which the interests of the general partner and the limited partners were not aligned if the transaction was approved by a majority of the members of the Audit and Conflicts Committee of EPE (the “Special Approval”) or satisfied one of three additional methods of resolving conflicts. The transaction at issue had received the Special Approval, and the Court found that the Special Approval provision was effective to contractually modify the general partner’s fiduciary duties. The Court further stated: “[w]hen a contract confers discretion on one party, the implied covenant [of good faith and fair dealing] requires that the discretion be used reasonably and in good faith.” Thus, according to the Court, the general partner had a duty, under the implied covenant, to act in good faith if it took advantage of the Special Approval process. However, the Court upheld a contractual presumption of “good faith.” Under the partnership agreement, the general partner was entitled to a presumption of good faith in making decisions if, among other things, it relied on a fairness opinion in determining to proceed with a conflict transaction. Here, the general partner received a fairness opinion from Morgan Stanley, and the Court declined to test the presumption. The Court noted that the implied covenant was a “gap-filler” and could not be used to infer provisions that contradicted the clear language of the contract.
Delaware Supreme Court Reverses Summary Judgment Order on Election of Remedies.
In GMG Capital Investments, LLC, et al. v. Athenian Venture Partners I, L.P., et al., Nos. 514, 2010 & 614, 2010 (Del. Jan. 3, 2012), the Delaware Supreme Court reversed a decision of the Superior Court on the issue whether plaintiffs’ remedy for breach of a note was limited by a “sole remedy” clause. Defendants argued that the agreement provided that plaintiffs’ sole remedy for breach was to take possession of the pledged collateral. However, the Superior Court found that plaintiffs’ remedy was not limited to taking possession of the collateral where another provision in the note provided that defendants were required to pay principal on the note in the event that one of two triggering events occurred. A triggering event occurred in 2008. However, defendants had not made the required payment on the basis that the “sole remedy” clause controlled.
Recent Corporate and Alternative Entity Decisions From the Delaware Courts
Posted : February 2nd, 2012Section 220 Action is not a Substitute for Litigation Discovery.
In Central Laborers Pension Fund v. News Corp., C.A. No. 6287-VCN (Del. Ch. Nov. 30, 2011), the Delaware Court of Chancery dismissed an action to inspect the books and records of defendant News Corporation (“News”), under Section 220 of the Delaware General Corporation Law (“Section 220”), on the basis that plaintiff’s purpose for making such a demand was not proper where plaintiff had already filed a derivative complaint against News. The derivative complaint alleged that News’s directors had breached their fiduciary duties in connection with a proposed acquisition of Shine Group Limited by News (the “Potential Transaction”). The 220 action sought books and records for the purpose of investigating potential breaches of fiduciary duty by the News board in connection with the Proposed Transaction. The Court found that, by filing its derivative complaint, plaintiff acknowledged—if for no other reason than to satisfy its lawyers’ ethical obligations—that it had sufficient information to support its substantive allegations in the complaint. Thus, plaintiff’s pleadings were inconsistent, and the Court ruled that Section 220 could not be used as a substitute for litigation discovery.
Chancery Court Addresses the Meaning of a Contractual Bad Faith Claim.
In Clean Harbors, Inc. v. Safety-Kleen, Inc., C.A. No. 6177-VCP (Del. Ch. Dec. 9, 2011), the Delaware Court of Chancery declined to dismiss plaintiff’s claim that defendant Safety-Kleen, Inc. (“Safety-Kleen”) breached a contractual obligation to make a good faith determination of the fair market value of its stock in connection with the exercise of a call right set forth in an option agreement. Plaintiff Clean Harbors, Inc. (“Clean Harbors”), a competitor of Safety-Kleen, acquired shares of Safety-Kleen subject to the call right from former Safety-Kleen employees, who held Safety-Kleen options, but did not have the funds to exercise the options before they expired. Clean Harbors financed the former employees’ exercise of the options and then bought the stock from the employees for $7.50 each, a small premium. However, only several hours after Clean Harbors closed its transaction with Safety-Kleen’s former employees, Safety-Kleen notified Clean Harbor that it was exercising a call right, under the option agreement, to purchase Clean Harbor’s shares at “fair market value,” which Safety-Kleen determined was $7.50—the same price Clean Harbors paid Safety Kleen’s former employees for their stock. Clean Harbors alleged that Safety-Kleen breached a contractual obligation to pay it the “fair market price” of the stock and an explicit obligation, under the option agreement, to make such determination in “good faith.” Specifically, Clean Harbors argued that $7.50 was a submarket price that Safety-Kleen’s former employees accepted only because they had no other means of salvaging some of the value of their options. Clean Harbors also argued that the $7.50 price reflected a discount for the stock being subject to a call right. The Court found that Clean Harbor’s allegations were sufficient to support a finding that the fair market value of the stock at issue was substantially higher than $7.50, and (2) Safety-Kleen had acted in “bad faith” in setting the call price. While Safety-Kleen argued that a contractual “bad faith” claim required Clean Harbors to establish that Safety-Kleen’s conduct constituted subjective bad faith–i.e., that its conduct was motivated by an actual intent to cause harm, the Court disagreed. Specifically, the Court found that the complaint need only allege facts related to the alleged act taken in bad faith and a plausible motivation for it. Because Clean Harbors plausibly alleged that Safety-Kleen was motivated by a desire to deprive a competitor from the benefits of its bargain (which also likely satisfied the “subjective” bad faith standard), the Court declined to dismiss its complaint.
Supreme Court Upholds Application of Spanish Law to a Triple Derivative Action.
In Sagarra Inversiones, S. L., v. Cementos Portland Valderrivas, S.A., C.A. No. 6179, J. Jacobs (Del. Dec. 28, 2011), the Delaware Supreme Court affirmed a Chancery Court decision holding that plaintiff, a stockholder of Cementos Portland Valderrivas, a Spanish Corporation (“CPV”), could not assert a derivative action on behalf of a third-tier, Delaware subsidiary of CPV where plaintiff lacked standing, under Spanish law, to bring such an action. Under Delaware law, a stockholder of a parent corporation may sue derivatively to enforce the claim of a wholly owned corporate subsidiary where the subsidiary and its parent wrongfully refuse to enforce the subsidiary’s claim directly. Spanish law does not permit so called “double” or “triple” derivative actions—in other words, a stockholder may only pursue a derivative action at the parent level. Plaintiff failed to make a demand on the board of the Spanish parent corporation as required, under Spanish law; thus, the Chancery Court dismissed plaintiff’s complaint. Plaintiff advanced three arguments in favor of the application of Delaware law to the action. First, plaintiff argued that Delaware law should be applied because it was suing to enforce a right possessed by a Delaware corporation, not a Spanish corporation. The Court rejected this argument on the basis that plaintiff’s standing to sue derivatively on behalf of a subsidiary must derive from its ownership of shares at the parent level because the parent corporation was the only corporation in which plaintiff owned stock. Second, plaintiff argued that standing was not a principle to which Delaware’s doctrine of internal affairs (which governs choice of law issues) should have been applied. The Court disagreed and found that the pre-suit demand requirement is a matter of internal affairs because it serves a core function of substantive corporation law by allocating, as between directors and stockholders, the authority to sue on behalf of the corporation. Finally, the Court rejected plaintiff’s third argument that public policy favored application of Delaware law. The Court agreed with the plaintiff that Delaware has a strong interest in policing alleged breaches of fiduciary duties, but found that Delaware courts could only fulfill that role where their power to act was first be properly invoked.
Advice of Counsel is not Outcome Determinative in Establishing Fair Dealing.
In Encite, LLC v. Soni, C.A. No. 2476-VCG (Del. Ch. Nov. 28, 2011), the Delaware Court of Chancery denied defendant directors’motion for summary judgment on the issue whether they conducted an entirely fair auction process for the sale of a now-defunct technology start-up, Integrated Fuel Cells Technologies, Inc. (“Integrated”), where the defendants relied largely on the defense that they had solicited and followed the advice of counsel. Integrated was a venture-backed company founded by Stephen Marsh (“Marsh”) which entered into an auction process to avoid bankruptcy. The Integrated board, which was comprised of Marsh, a Marsh designee, two designees of Echelon Ventures L.P. (“Echelon”), its largest investor, and an independent director, did not hire an investment advisor to conduct the auction, but did manage to solicit some interest, including an Echelon-backed bid and a Marsh-backed bid. Ultimately, the board approved the Echelon-backed bid, and Marsh sent an e-mail to all stockholders that the board was conflicted and had ignored superior offers. After several stockholders brought derivative claims, all members of the Integrated board resigned other than Marsh, who then abandoned the auction and entered the company into bankruptcy. A Marsh affiliate then purchased Integrated’s assets in bankruptcy and brought this action against the former Integrated directors other than marsh. Plaintiff alleged that defendants breached their fiduciary duties in approving the unconsummated transaction with an Echelon affiliate—essentially asking the Court to determine whether the defendants squandered an opportunity to realize the true value of the company by attempting to force through an inferior transaction in which they were interested. On this motion for summary judgment, defendants asked the Court to find that their actions passed muster under the exacting entire fairness standard of review applicable to interested transactions. The Court denied the motion on the basis that defendants had not set forth any evidence from which it could make that decision. Instead, the defendants relied on conclusionary statements that the process had been fair because their counsel told them it was a fair process. The Court noted that reasonable reliance on expert counsel is a pertinent factor in evaluating whether corporate directors have met a standard of fairness in their dealings with corporate powers; however, its existence is not outcome determinative. The Court also expressed doubts about plaintiff’s ability to demonstrate damages at trial given the Court’s determination that the proper measure of damages would be the difference between Integrated’s value before the defendants resigned as directors and the value achievable by Marsh afterwards. Finding that Marsh was not required to abandon the auction or cause Integrated to enter into bankruptcy (i.e., he could have sold the assets for more) the Court rejected Marsh’s argument that the measure of damages should be the difference between what plaintiff paid for the assets in bankruptcy and the assets highest value during the bidding process.
Earn-Out Payments in Merger Agreements and the Implied Covenant.
In Winshall v. Viacom Int’l, Inc., C.A. No. 6074-CS (Del. Ch. Nov. 10, 2011), the Delaware Court of Chancery rejected plaintiff’s argument that both the seller and the acquirer of a business possessed an affirmative duty under the implied covenant of good faith and fair dealing to take an opportunity to increase the potential earn-out payments to the seller’s stockholders under a merger agreement in which the stockholders possessed no reasonable expectancy interest. In 2006, defendant Viacom International (“Viacom”) acquired defendant Harmonix Music Systems, Inc., a creator of music-oriented gaming systems (“Harmonix”). Under a merger agreement entered into among Viacom, Harmonix and certain Harmonix stockholders in 2006, Harmonix’s stockholders were entitled to receive an up-front cash payment for their shares, as well as a contingent right to receive uncapped earn-out payments based on Harmonix’s financial performance in the two years following the merger, 2007 and 2008. About one year after the merger closed, Harmonix released a new video game, which was very successful, and Harmonix renegotiated an existing contract it had with a third party for the distribution of the game. As part of the renegotiation, Harmonix was able to obtain a wider distribution of its product and a reduction in distribution fees, in upcoming years, following the expiration of the earn-out period. In this action, plaintiff alleged that the defendants breached the implied covenant of good faith and fair dealing by not negotiating for a reduction in distribution fees during the earn-out period. The Court found inequitable the proposed imposition of a duty on the defendants to share with Harmonix’s stockholder the benefits of a renegotiated contract addressing distribution rights after the expiration of the earn-out period. According to the Court, the implied covenant of good faith and fair dealing requires a party to refrain from conduct that is contrary to the fundamental expectations of the other party as implied by the explicit terms of the deal. In this case, plaintiff sought to actually expand “its contractual counterparty’s expectancy as a matter of judicially compelled charity, not toward a 501(c)(3), but toward another sophisticated commercial actor.” Slip. Op. at 21. Accordingly, the Court dismissed plaintiff’s complaint.
These case summaries are intended for informational purposes only.
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Recent Corporate and Alternative Entity Decisions From the Delaware Courts
Posted : September 28th, 2011Chancery Court Holds Provision Prohibiting Asset Transfer Not Violated by Sale of Equity Interest in Asset.
In Roseton OL, LLC v. Dynegy Holdings, Inc., C.A. No. 6689-VCP (Del. Ch. July 29, 2011), the Court of Chancery found that plaintiffs were not likely to succeed on the merits of their claims that Dynegy Holdings, Inc. (“DHI”) would violate promises made pursuant to clauses of guaranties it had made in favor of plaintiffs’ parent company that prohibited DHI from transferring its “properties and assets substantially as an entirety.” The asset transfer that plaintiffs claimed would violate the guaranties was a proposed transfer by DHI of its entire equity interest in subsidiaries that held DHI’s most profitable power plants to new bankruptcy remote DHI subsidiaries. The Court found that the provision at issue did not likely apply, stating its opinion that the phrase “properties and assets” referred to properties and assets directly owned by DHI, not DHI’s equity ownership interests in subsidiaries. Accordingly, the Court denied the plaintiffs’ request for a temporary restraining order.
Chancery Courts Denies Motion to Expedite Conflict Transaction Negotiated by Special Committee Except on Limited Disclosure Grounds.
In a recent decision on a motion to expedite, In re Ness Technologies, Inc. S’holders Litig., C.A. No. 6569-VCN (Del. Ch. Aug. 3, 2011), the Delaware Court of Chancery confirmed that a conflict transaction negotiated by a fully functioning special committee would not be second-guessed by the Court. This decision involved a putative class action lawsuit filed by stockholders of defendant Ness Technologies (“Ness”), who sought to enjoin a proposed transaction through which Ness’s largest stockholder, defendant Citi Venture Capital International (“CVCI”), would acquire Ness in a cash transaction at $7.75 per share. The Plaintiffs challenged the transaction on both price and process grounds and also alleged that the disclosures by Ness relating to the proposed transaction were inadequate. The Court found that the plaintiffs had not articulated sufficiently colorable price or process claims to justify expedition where: (1) the transaction had been approved by a disinterested special committee following an eleven-month sales’ process involving approximately thirty bidders; and (2) the parties merger agreement contained “relatively mundane” deal protection measures (standard “no-shop” and “no talk” provisions with fiduciary-outs and a termination fee amounting to 2.72 % of the transaction price). However, consistent with recent decisions emphasizing the importance of financial advisor independence, the Court granted the plaintiffs’ motion to expedite on the limited issue whether Ness’s financial advisor was conflicted due to past, present or future dealings with CVCI.
Chancery Court Interprets LLC Agreement to Allow Transfer of Membership Interests Without Consent of All Members
In Achaian, Inc. v. Leemon Family, LLC, et al., C.A. No. 6261-CS (Del. Ch. Aug. 9, 2011), the Court of Chancery granted a declaratory judgment in favor of Achaian, Inc. (“Achaian”), a member of Omniglow, LLC (“Omniglow”) and ordered the dissolution of Omniglow under 6 Del. C. § 18-802 based on a 50/50 deadlock between the members of Omniglow. In determining that Omniglow was owned by two members each with a 50% limited liability company interest, the Court rejected the other member’s claims that a provision prohibiting the admission of new members without all members’ consent would prohibit one member from transferring its interest to another member without all members’ consent. The Court noted that Omniglow’s LLC agreement explicitly permitted a member to transfer “all or any portion of its [i]nterest in [Omniglow] to any [p]erson at any time,” and in granting judgment in favor of Achaian, the Court opined that it “would make scant sense” to transfer only economic rights and not the entire interest in Omniglow, including voting rights, as the definition of “Interest” in the LLC agreement referred to the “entire ownership interest of the [m]ember in [Omniglow].”
Delaware Supreme Court Affirms Chancery Court Decision on Indemnification for Contingency Fees.
In IAC/Interactive Corp., v. Brien, C.A. No. 629, 2010 (Del. Ch. Aug. 11, 2011), the Delaware Supreme Court affirmed the Court of Chancery’s determination that contingent fees are fees that are “incurred” for purposes of Section 145 of the Delaware General Corporation Law (“Section 145”), such that a corporation is required to indemnify a person otherwise entitled to be indemnified under Section 145 for reasonable contingent fees. In so finding, the Court rejected the defendant corporation’s argument that premium or contingent fees are not fees that are actually “incurred” because they do not represent work done, but rather the success achieved. The Court found that whether the amount of the fee was determined upfront or after the result was obtained was immaterial because the fee was still incurred. The Court also found that the Court of Chancery had not abused its discretion in finding reasonable the following contingent fee arrangements: (1) a 20% success fee to one firm who was defending the indemnified person in an arbitration proceeding; (2) a $100 per hour increase is the same firm’s hourly rates for all work done after the arbitration was completed; (3) a 50% premium above standard hourly rates to a second firm; and (4) a contingent $100 per hour premium above standard hourly rates to a third firm.
Chancery Court Prohibits Hedge Fund Manager’s Use of Gate Provision to Restrict Withdrawal of Capital under Revenue Sharing Agreement
In Paige Capital Management, LLC, et al. v. Lerner Master Fund, LLC, et al., C.A. No. 5502-CS (Del. Ch. Aug. 8, 2011), the Court of Chancery refused to permit the management of a hedge fund (the “Paige Fund”) to use a so-called “Gate Provision” of a partnership agreement (the “Partnership Agreement”) to restrict the withdrawal by the Paige Fund’s only outside investor of its entire investment, pursuant to the terms of its revenue sharing agreement (the “Seeder Agreement”). In October 2007, an investment vehicle called the Lerner Fund agreed to invest $40 million of “seed” capital into the newly created Paige Fund. The Lerner Fund entered into the Partnership Agreement through one of the Paige Fund’s investment vehicles, as well as the Seeder Agreement, which governed the relationship between the Paige Fund and the Lerner Fund, to the exclusion of any other potential limited partners. After three years and no new investors, the Lerner Fund decided to withdraw its entire capital investment, pursuant to the terms of the Seeder Agreement. However, the Paige Fund attempted to restrict this withdrawal, based on a “Gate Provision” contained in the Partnership Agreement that permitted the general partner to limit the withdrawal of any limited partners’ investments to 20% of the total capital investments. The Paige Fund argued that the Partnership Agreement had not been “amended” by the provisions of the Seeder Agreement, while the Lerner Fund argued that no amendments were necessary since the Partnership Agreement permitted the general partner to waive the Gate Provision. The Court, using New York law contract analysis, agreed with the Lerner Fund that the Gate Provision was superseded by the Seeder Agreement and that the Seeder Agreement was tantamount to a side letter between the general partner and the Lerner Fund, and that even had it not been, the fiduciary duties of the Paige Fund’s general partner would have required it to waive the Gate Provision. After a lengthy analysis, the Court found that with respect to Section 17-1101(e) of the Delaware Revised Uniform Limited Partnership Act (DRULPA), the general partner of the Paige Fund and the managing member of the general partner had breached their fiduciary duties by favoring their own interests over those of the investor in invoking the Gate Provision.
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