The Court in LSVC Holdings, LLC v. Vestcom Parent Holdings, Inc., C.A. No. 8424-VCMR, rejected the buyer’s interpretation of a provision in a stock purchase agreement that would have ignored seller’s rejection of such terms contained in drafts of the agreement. In addition to the importance of the parties’ drafting history, the decision illustrates the challenges presented when parties have to address in detail the general understanding of the parties as set forth in a letter of intent.
BOTTOM LINE: Think twice before you throw out drafts of agreements exchanged with the other party!
The Court in AIU Insurance Co., et.al. v. Philips Electronics North America Corp., et al., C.A. No. 9852-VCS reminds us that if a provision in an agreement has two or more meanings, it is ambiguous and the Court will decide its meaning.
At issue was the meaning of the word “audit” that was not defined in the agreement. As a result, the parties were in dispute as to the scope of information accessible in an “audit”.
BOTTOM LINE: The definition section of an agreement is key. Do not ignore the need to set out in detail what the parties should expect.
In Pierre Schroeder, et al. v. Philippe Buhannic, et al., C.A. No. 2017-0746-JTL, the Court was asked to consider the validity of a shareholder consent that removed a CEO and appointed a new CEO and Chairman of the Board.
Although there was a provision in a stockholder agreement that required shareholders to vote their shares to elect “three (3) representatives designated by the holders of the majority of the common stock, one of whom shall be the Chief Executive Officer of the Company”, the Court reminds us that if shareholders wish to limit the power of the board to manage the corporation, including the right to select the CEO, this power needs to be restricted in the certificate or bylaws of the corporation.
BOTTOM LINE: Do not assume that the provisions of a shareholder agreement will be enforceable without first considering (i) whether or not the provision is permitted under the DGCL, (ii) how the Delaware Courts have interpreted the relevant DGCL provision and (iii) what must be addressed in the Certificate or bylaws of the corporation to enable a shareholder agreement to address the issue.
In SRL Mondani, LLC v. Mondani Spa Resort, Ltd., the Superior Court addressed competing forum-selection clauses found in multiple agreements made in connection with a loan facility. The defendants filed a motion to dismiss arguing that one agreement, which mandated Israel courts as the exclusive forum for all disputes (the “Iska Agreement”), superseded the forum-selection clauses in all other agreements related to the loan facility. The Court disagreed and determined that the forum-selection clause in the Iska Agreement was not applicable because the plaintiffs were not attempting to enforce the terms of the Iska Agreement. Instead, the claim being pursued by the plaintiff arose under the terms of a separate agreement that mandated Delaware as the exclusive forum for disputes. As a result, the Court denied the defendant’s motion to dismiss.
BOTTOM LINE: In order to avoid needless litigation, you should ensure that all forum-selection clauses in agreements related to the same transaction choose the same forum for the resolution of disputes!
In Re Cyan, Inc. Stockholders Litigation provides an excellent example of the power of the Corwin Presumption when a shareholder vote is fully informed and uncoerced. There, the Court of Chancery dismissed a claim that board members of a Delaware corporation breached their fiduciary duty by approving a merger based on their own self-interest. The Court found that the merger at issue had been approved by a majority vote of fully informed, disinterested stockholders. As a result, the business judgment rule applied and, because the plaintiffs failed to plead that the merger constitutes waste under Delaware law, their claim was dismissed.
BOTTOM LINE: The approval of a merger by an informed, uncoerced majority of disinterested shareholders will result in the application of the business judgment rule and a likely dismissal of all post-closing fiduciary duty claims.
In Sciabacucchi v. Liberty Broadband et al., the Delaware Court of Chancery refused to apply the business judgment standard of review to an equity issuance completed in connection with two acquisitions (the “Acquisitions”) made by a Delaware corporation (“Charter Communications”). The plaintiff, a shareholder of Charter Communications, filed suit against the directors of Charter Communication for breach of fiduciary duty in connection with their issuance of equity to the largest stockholder, Liberty Share, of the company purportedly to help finance the Acquisitions (the “Issuance”). The Acquisitions and the Issuance were both approved by separate votes of the majority of shareholders unaffiliated with Liberty Share. Nevertheless, the plaintiff argued that the shareholder approval of the Issuance was coerced because the largest shareholder controlled the Board.
The Court disagreed and determined that Liberty Share did not control the Board. However, the Court did find that the unaffiliated shareholder approval of the Issuance was “structurally coercive” because the directors made completion of the lucrative Acquisitions contingent upon the shareholders’ approval of the inequitable Issuance. In other words, to receive the full benefit of the Acquisitions, the shareholders had to “swallow the pill” of the Issuance. As a result, the Court refused to apply the business judgment standard of review under the Corwin Presumption.
BOTTOM LINE: Delaware courts will not uphold a shareholder vote unless the shareholders were truly free to accept or reject a transaction without structural restraints.
The question of whether or not a claim for advancement was subject to arbitration was a question for the arbiter, according to the Court of Chancery.
In Glazer, et al. v. Alliance Beverage Distributing Co. LLC, a limited liability company agreement (“LLC Agreement”) provided that:
Any controversy or claim arising out of or relating to this Agreement, or the breach thereof, shall be settled by arbitration in the State of Arizona administered by the American Arbitration Association under its Commercial Arbitration Rules and the Supplemental Procedures for Large, Complex Disputes, and judgments on the award rendered by the arbitrators may be entered in any court having jurisdiction thereof.
In response to a claim for advancement, the Court determined that it did not have the right to decide whether or not a claim for advancement was subject to arbitration. While such an issue is generally left to the Delaware courts to decide, the LLC Agreement at issue required an arbitrator in Arizona to make this determination. As a result, the Court stayed the claim so that an Arizona arbitrator could determine whether or not a claim for advancement was subject to arbitration.
BOTTOM LINE: Careful; giving the right to determine whether or not a claim must be arbitrated to an arbitrator may delay the resolution of a claim, even when the claim at issue is one that may be subject to the right of the Court to summarily determine the issue.
In Brinckerhoff v. Enbridge Energy Company, Inc., et al., long-term investors of a publicly-traded Delaware limited partnership (the “MLP”) claimed that the General Partner (the “GP”) breached its contractual duty of good faith when the GP agreed to what investors considered an unfair transaction that was influenced by a conflict of interest by intentionally breaching specific requirements of the MLP’s partnership agreement (the “LPA”) by agreeing to a conflicted, unfair transaction (the “Transaction”). Notably, the LPA replaced traditional fiduciary duties with a contractual duty of good faith.
The Court of Chancery dismissed the plaintiffs’ claims for failing to plead a breach of the contractual duty of good faith. On appeal, the Delaware Supreme Court reversed the Court of Chancery’s decision and held that the LPA’s general good faith standard did not displace specific affirmative obligations of the LPA. To hold otherwise would arguably allow the GP to breach other obligations of the LPA as long as it did so in good faith.
In reaching its conclusion, the Court considered the following provisions of the LPA:
a contractual duty of good faith which eliminated traditional fiduciary duties. However, the provision failed to define the term “good faith.” (“Section 6.10”);
a provision to the effect that “[t]he [GP] may not, without written approval of the specific act by all of the Limited Partners . . . take any action in contravention of this Agreement . . . .” (“Section 6.3”);
a provision to the effect that “[n]either the [GP] nor any of its Affiliates shall sell, transfer or convey any property to, or purchase any property from, the Partnership, directly or indirectly, except pursuant to transactions that are fair and reasonable to the Partnership.” (“Section 6.6”); and
a provision that exculpated the GP for monetary damages for actions taken in good faith.
The Supreme Court disagreed with the Court of Chancery and its determination that the plaintiffs were required to show that the GP acted in bad faith under Section 6.10 before it could be determined that the GP breached the “fair and reasonable” standard of Section 6.6. Instead, the Court found that Section 6.6 was an affirmative obligation the GP was required to satisfy, while Section 6.10, “on the other hand, was a general standard of care that operates in the spaces of the LPA without express standards.” “Although [the] GP must act in good faith under the LPA, and is not subject to fiduciary standards of care, it still must comply with the specific requirements of the LPA.” Further, the Court found that, although Section 6.8 immunized the GP from monetary damages, it did not absolutely immunize the GP because equitable remedies were still available to plaintiffs.
Finally, the Court reversed prior precedent that held that pleading bad faith required a showing that the decision at issue was “so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.” Instead, the Court determined that plaintiffs need only show that the GP did not reasonably believe its action to be in, or not inconsistent with, the best interests of the Partnership.
BOTTOM LINE: Obligations negotiated in a limited partnership agreement cannot be ignored even if a general partner acts in good faith. The same principal should also apply in the LLC context.
In In Re Saba Software, Inc. Stockholder Litigation, the defendants argued that a conflicted merger had been cleansed by a fully informed, uncoerced vote of disinterested shareholders. The Court rejected the defendants’ argument and concluded that the shareholder vote was not informed given the proxy statement contained material omissions. The Court also found that the lack of information in the proxy statement had a coercive effect that left the shareholders with no choice but to approve the merger. As a result, the shareholder vote did not “cleanse” the conflicts of interest that existed.
The Saba decision illustrates the distinction between form and substance. In contrast to Saba, the Delaware Supreme Court held in Corwin v. KKR Financial Holdings LLC that the business judgment standard of review will apply to transactions subject to enhanced scrutiny if a majority of disinterested stockholders approve the transaction and are not coerced unless the challenged transaction involves a conflicted controller. Since that time, the Delaware Court of Chancery has expanded the “Corwin Presumption” to apply to transactions generally subject to entire fairness (except for those involving a conflicted controller) and, on that basis, has dismissed several plaintiff-shareholder lawsuits by applying the business judgment rule. However, the vote itself works only if complete information is provided and there is no coercion.
BOTTOM LINE: The fact that a vote of shareholders was taken will not guarantee application of business judgement rule; substance matters! The facts underlying the vote matter.
A Forum Selection Clause that Identifies Multiple Forums Must Set Forth the Types of Claims that Will be Determined in Each Forum
The Delaware Court of Chancery examined a claim by two former managers of a Delaware LLC for the advancement of their legal expenses. The LLC’s operating agreement contained a mandatory forum-selection clause that provided: [T]he parties “agree that any suit, action, or other legal proceeding arising out of this Agreement shall be brought in the United States District Court for the Southern District of New York or in any courts of the state of New York sitting in the Borough of Manhattan. . . .”
The forum-selection clause also contained a carve-out provision to the effect that “[a]ny legal proceeding arising out of this Agreement which, under [Delaware’s Limited Liability Company] Act or, to the extent made applicable to the Company pursuant to this Agreement, the DGCL, is required to be brought in the Delaware Court of Chancery may only be brought in the Delaware Court of Chancery and the parties hereto hereby consent to the jurisdiction of the Delaware Chancery Court under such circumstances.”
The former managers argued that the carve-out applied to their claim because the forum-selection provision incorporated the DGCL, which they contended requires all advancement claims brought by Delaware entity officers or directors be filed in the Court of Chancery.
The Court rejected this argument for two reasons. First, the court found that the forum-selection provision did not incorporate the DGCL. Second, the Court found that even if the DGCL had been incorporated, the DGCL does not require that all advancement proceedings be brought in the Court of Chancery to the exclusion of courts in other jurisdictions.
BOTTOM LINE: LLC managers may contractually agree in an LLC’s operating agreement that claims arising out of the LLC Agreement must be brought exclusively in a jurisdiction other than Delaware. A forum-selection clause identifying multiple jurisdictions must clearly set forth the types of claims that will be determined in each forum. Notably, the parties did not address the effects, if any, that Section 18-109(d) may have had on the forum-selection clause at issue.
“Good Faith” is Required Where Action Was “Obviously” Intended to be Conditioned on the “Absence of Bad Faith”
Limited partners of a publicly traded Delaware limited partnership (the “MLP”) claimed that the General Partner (the “GP”) of the MLP failed to satisfy the safe harbors provided in the MLP’s partnership agreement to cleanse a conflict before approving a merger with an affiliate. The MLP’s partnership agreement contained two safe harbor provisions: (1) approval by an independent Conflicts Committee, or (2) the approval a majority of limited partners unaffiliated with the GP. The MLP partnership agreement did not address how the GP was required to conduct itself when seeking limited partner approval. However, the partnership agreement eliminated fiduciary duties and the only requirement in the MLP partnership agreement relating to a merger was that the GP provide a copy of the merger agreement to the limited partners.
The Court of Chancery ruled that the second safe harbor in the MLP partnership agreement had been satisfied. Although plaintiffs argued that proxy statement distributed to them contained materially misleading disclosures, the Court of Chancery determined that “the express waiver of fiduciary duties and the clearly defined disclosure requirement . . . prevent[ed] the implied covenant [of good faith and fair dealing] from adding any additional disclosure obligations to the agreement.” As a result, the Court dismissed the plaintiffs’ claim.
On appeal, the Delaware Supreme Court reversed the Court of Chancery’s decision. The Court determined that the express terms of the safe harbor provisions “naturally and obviously” implied certain conditions including “a requirement that the [GP] not act to undermine the protections afforded unitholders in the safe harbor process.” The Court applied the rarely-used doctrine of good faith and fair dealing to hold that the GP was bound to use good faith when obtaining safe harbor approval.
BOTTOM LINE: The express elimination of fiduciary duties in a limited partnership agreement has no effect on the application of the implied covenant of good faith and fair dealing. If a safe harbor is included in a partnership agreement, the GP will be subject to an implied duty to obtain safe harbor approval in a good faith manor.
A corporate bylaw that permitted stockholders to remove directors with or without cause only upon the vote of “not less than 66 and two-thirds percent . . . of voting power of all outstanding shares” of the company was found to be invalid under Delaware law. Specifically, the Court of Chancery held that the bylaw provision directly violated Section 141(k) of the Delaware General Corporation Law (“DGCL”), which provides that “[a]ny director or the entire board of directors may be removed, with or without cause, by the holders of a majority of the shares then entitled to vote at an election of directors.”
BOTTOM LINE: Corporate directors may only be removed by a majority of shareholders entitled to vote at an election of directors. Although this standard may not be modified in bylaws, there is a possibility that the right may be modified in a certificate of incorporation.
NOTE: Whether the “majority” standard can be modified by a corporation’s certificate of incorporation is not entirely clear, and the Court in Frechter was careful to note that the matter before it “involve[d] a bylaw provision with no consideration of any provisions contained in the corporation’s certificate of incorporation.”
The Delaware Court of Chancery reviewed a shareholder’s challenge to a fee-shifting provision found in a forum-selection bylaw that required all internal corporate claims be brought in Delaware. The bylaw also provided that any shareholder “who fails to obtain a judgment on the merits that substantially achieves … the full remedy sought, shall be obligated to reimburse [the corporation] for the attorneys’ fees and other expenses it incurred in connection with such action.” Although no internal corporate claim had yet been filed outside of Delaware, the Court determined that the shareholder’s action was ripe for review because of the substantial deterrent effect of the bylaw. The Court struck down the fee-shifting provision of the bylaw as a direct violation of Section 109(b) of the DGCL, which prohibits the use of a bylaw that imposes liability on shareholders for attorneys’ fees or expenses in connection with an unsuccessful internal corporate claim. The Court rejected the argument that Section 115, which permits Delaware organizational documents to choose Delaware as an exclusive forum for all internal corporate claims, and Section 109(b) were meant to be read together. The Court determined that 109(b) was intended to prohibit fee-shifting for all internal corporate claims, even when those claims are filed outside of Delaware in violation of an exclusive forum bylaw. The Court noted that Section 109(b) and Section 115 make no reference to one another and found that the plain text of Section 109(b) prohibits “any provision” that would shift fees in connection with an internal corporate claim.
BOTTOM LINE: Regardless of the structure of the bylaw, any provision that purports to shift fees to the shareholders in connection with an internal corporate claim is facially invalid. Delaware corporations should avoid any attempt to vary the rule as doing so will open the corporation up to shareholder claims such as breach of fiduciary duty.
The Delaware Court of Chancery was asked to award a quasi-appraisal to remedy a purported breach of the duty of disclosure in connection with a short-form merger. The merger, which was approved by a Special Committee of the Board of the target corporation, closed in September 2015.
The Court reiterated that in a short-form merger, the entire fairness standard of review is inapplicable and, absent fraud or illegality, the only remedy available to a minority shareholder dissatisfied with the merger consideration is appraisal. The Court further emphasized that, while entire fairness does not apply to such mergers, the duty of disclosure does. As a result, notice of the merger sent to the minority shareholders must disclose all “information material to the decision of whether or not to seek appraisal. . . .” Information is material if there is a “substantial likelihood that the undisclosed information would significantly alter the total mix of information already provided.”
In rejecting the plaintiff’s quasi-appraisal claim, the Court determined that the eighty-page notice sent to the minority shareholders was sufficient because it set forth: (i) sufficient financial data; (ii) the reasoning behind the parent corporation’s offering price; (iii) necessary information regarding the Special Committee’s determination of fair price of the target corporation; (iv) the target corporation’s amount of cash, cash equivalents, and the planned use of each; and (v) facts showing the independence and, where applicable, the potential conflicts, of the members of the Special Committee.
BOTTOM LINE: Notification of a short-form merger must contain all information that is substantially likely to significantly alter the total mix of information already provided to the minority shareholders.
The Delaware Court of Chancery dismissed a complaint that alleged breach of fiduciary duty against directors that approved a merger. The Court concluded that the merger, which would generally have been subject to enhanced scrutiny review, was cleansed by the fully informed, uncoerced vote of the disinterested stockholders. As a result, the business judgment rule applied and, in order to move forward, the plaintiff was required to prove that the directors’ decision constituted waste.
BOTTOM LINE: The fully informed, uncoerced vote of a disinterested majority of shareholder will cleanse a challenged transaction that would generally be subject to enhanced scrutiny.
The Delaware Supreme Court reversed a Delaware Court of Chancery decision that dismissed a derivative complaint based on the plaintiff-shareholder’s failure to make a pre-suit demand on the Company’s board of directors. The Court of Chancery had determined that because the majority of the board was independent, the plaintiff-shareholder was required to make a demand on the Board to file suit on behalf of the Company. On appeal, the Delaware Supreme Court disagreed and found that the plaintiff-shareholder had shown that the majority of the board of directors was conflicted and thus a pre-suit demand was not necessary. The Court’s decision was based on several different conflicts amongst three board members, including the co-ownership of an airplane between one director and the controlling stockholder of the company, and two other directors’ “interlocking” financial ventures and relationships with the controlling shareholder. Notably, the Court admonished the plaintiff for failing to direct a books and records request to the Company on issues bearing on the board members’ independence, finding that “the plaintiff‘s lack of diligence put the Court of Chancery in a compromised and unfair position to make an important determination regarding these directors’ pleading stage independence.”
BOTTOM LINE: Delaware courts will review the independence of directors in as detailed a fashion as they review the independence of financial advisors. As a result, plaintiffs must be extremely diligent in their review of a board’s independence before determining that a pre-suit demand on the board is unnecessary.
The Delaware Court of Chancery addressed a claim of fraud in connection with the purchase of six subsidiary companies of ValueClick, Inc. made pursuant to a Purchase Agreement. The plaintiff-buyer alleged that ValueClick, Inc. fraudulently induced it to overpay for one of the subsidiaries. The Court found that this claim was foreclosed based on the combination of an affirmative anti-reliance clause and an integration clause found in the Purchase Agreement. The anti-reliance clause stated: “The Buyer acknowledges that neither the Seller nor any of its Affiliates or Representatives is making, directly or indirectly, any representation or warranty with respect to any [purchase-related information], unless any such information is contained in [this Agreement].” The Purchase Agreement’s integration clause set forth standard integration language that clearly defined the writings that comprised the parties’ agreement.
BOTTOM LINE: In order to foreclose claims of fraud based on statements or omissions made outside the terms of a contract, the contract must contain an affirmative disclaimer that either: (1) specifically includes what the party claiming fraud is relying upon when it decides to enter into the agreement or (2) that the party claiming fraud was not relying on any representations made outside of the agreement.
If your deal documents do not properly establish which document trumps another, the unintended results may be very costly.
In this connection, please see a new Delaware Supreme Court opinion by clicking here.
It is a reminder to take extra care with your subscription documents, side letters, LLC agreements, partnership agreements and series provisions, just to name a few.
The Delaware Court of Chancery addressed a petition for judicial dissolution of a Delaware limited liability company (the “Company”). The court began its analysis by noting that judicial dissolution of an LLC is granted sparingly and is only proper when “it is not reasonably practicable to carry on the business in conformity with a limited liability company agreement.” Both the petitioner and the respondents agreed that the Company was deadlocked and needed to be dissolved. However, the respondents did not want the dissolution of the Company to negatively affect their position in a separate action being litigated in California. To resolve this problem, the Court issued an order that dissolved the Company but mandated that the dissolution not foreclose or affect the respondents’ standing in the separate California Action.
BOTTOM LINE: You can avoid deadlock between the members of an LLC by carefully drafting the operating agreement to account for such a situation. A sound operating agreement will provide the process that must be used to resolve a deadlock. For example, the operating agreement could include a dispute resolution clause, which requires the parties that are deadlocked to submit the issue to a neutral third party for resolution.
NOTE: This is an interesting case in that it involves a Delaware Court ordering a party not to use a specific defense in an out-of-state action as a condition to judicial dissolution. As such, it involves principles of equity under Delaware law as well as principles of choice of law. If appealed, this case should be closely observed to see how the Delaware Supreme Court addresses the interplay between both sources of law.
The Delaware Supreme Court was asked to review a Court of Chancery decision that determined the profits of a successful investment entity would be distributed in accordance with the dictates of an LLC Agreement only. Ancillary documents, including a term sheet and clawback agreement, would not be considered. The Court determined that such ancillary documents were secondary agreements, which applied only to reallocate the distributions made pursuant to the LLC operating agreement.
BOTTOM LINE: If transaction documents do not properly establish a hierarchy of authority among them, unintended consequences may result. As a result, when entering an investment venture, it is vital to understand the intertwining relationship among transaction documents.