In Akorn, Inc. v Fresenius Kabi AG, C.A. No. 2018–0300–JTL, the Chancery Court permitted a buyer to terminate a merger agreement including language to the effect that disproportionate industry effects should be taken into account in determining whether there had been a material adverse effect.
After the execution of the merger agreement, (i) the target’s EBITDA decreased by 86% in the year after the execution of merger agreement, (ii) the target significantly changed its business operations, and (iii) the acquiror’s investigations found problems with seller quality control which could be in violation of applicable regulatory requirements.
Even if the seller could not represent that its representations in the merger agreement were true and correct at the time of closing, the merger would move forward except when such failure “would not be reasonably expected” to result in a material adverse effect.
The Court found there was evidence that the seller’s downturn exceeded that of its peers and was disproportionate to the unforeseen competition in the industry.
BOTTOM LINE: The Court suggested that the parties could have excluded specific matters from the definition of material adverse effect; take the time and make the effort to do so!
In Almond et al. v. Glenhill Advisors LLC, C.A. No. 10477-CB, the Chancery Court denied post-trial claims challenging a series of transactions leading to the acquisition of a company. Prior to the acquisition, the certificate of incorporation was amended to implement a reverse stock split. After the reverse stock split, the acquiror had sufficient shares to move forward with a short-form merger. After the merger closed, it was discovered that the reverse split was mistakenly structured to reduce by a factor of 2500-to-1, instead of 50-to-1. The sole stockholder of the company remaining after the merger approved a DGCL Section 204 resolution to ratify the actions taken to cure the mistake. The former minority stockholders of the company argued that as a result of the mistake, the acquiror did not have enough shares to affect a short term merger. The Court disagreed and granted judicial ratification under DGCL Section 205 given the mistakes were unintended and the acquiror took prompt action to fix the mistakes after its discovery.
BOTTOM LINE: Acknowledge and cure mistakes promptly to reap the benefits of DGCL section 205.
Note The Difference Between Preliminary Discussions And Negotiations In The Context Of MFW Requirements.
In Olenik v. Lodzinski, C.A. No. 2017-0414-JRS, a controlling stockholder conducted discussions with a target for approximately nine months before making a formal offer. As a result, the plaintiffs argued that the controlling stockholder failed to meet the requirements of MFW which require the controlling stockholder to condition a transaction on the uncoerced approval by both an independent special committee and an informed majority of the minority stockholders in order to obtain the benefit of business judgement deference.
The Court disagreed with plaintiff’s proposition that the controlling stockholder failed to meet the requirements and noted the distinction between “preliminary discussions” and “negotiations”. The Court opined that “in most instances, ‘negotiations’ begin when a proposal is made by one party which, if accepted by the counter-party, would constitute an agreement between the parties regarding the contemplated transaction.” The requirement is triggered from the “outset of negotiation” and not by “extensive preliminary discussions”. The Court noted that the negotiation process did not start until the Company submitted an offer letter which was “the first real move in the negotiating bout”. The preliminary discussions did not amount to bargaining but just exploratory exchanges, and did not include discussions on the price, which was a distinguishing feature of negotiations.
BOTTOM LINE: You do not lose the benefit of the business judgement rule when you explore possibilities and do not address price.
When Common Law Fiduciary Duties Are Unambiguously Eliminated In A Limited Partnership Agreement, Recourse Against The General Partner Is Limited To Breach Of Contract Claims.
In Wenske et al. v. Blue Bell Creameries, Inc., C.A. No. 2017-0699-JRS, the limited partnership agreement required the general partner to “use its best efforts to conduct…business…in accordance with sound business practices in the [dairy industry]”. When bacterial contamination was found in ice cream products, the partnership suspended production and distribution of its dairy products and was fined for poor food safety policies and practices. The plaintiffs sued the defendants including the general partner of the partnership for breach of the limited partnership agreement. The defendants argued that the limited partnership agreement did not incorporate government guidelines for the industry that the plaintiffs relied on in their pleadings. The Chancery Court ruled that the terms should be given their plain meaning and interpreted according to a reasonable person’s understanding. According to the Court, the wording “sound business practices” referred to government guidelines and accepted practices. In addition, the Court made it clear that given the partnership agreement unambiguously eliminated common-law fiduciary duties, the plaintiffs correctly characterized the claim as a breach of contract.
BOTTOM LINE: Consider including the following language in a partnership or LLC agreement which has been found by the court to unambiguously eliminate common law fiduciary duties: “[a]ny standard of care and duty imposed by this Agreement or under [DRULPA] or any applicable law, rule or regulation shall be modified, waived or limited, to the extent permitted by law, as required to permit [the general partner] to act under this Agreement or any other agreement contemplated by this Agreement and to make any decision under the authority prescribed in this Agreement, so long as the action is reasonably believed by [the general partner] to be in, or not inconsistent with, [the partnership’s] best interests.”
Parent Of Buyer Is Not Responsible To Seller For Obligations Unless The Agreement Includes Such Obligation.
In US Ecology, Inc. v. Allstate Power Vac, Inc., C.A. No. 2017-0437-AGB (June 18, 2018), the parent of the seller sued both the buyer and the buyer’s parent for reimbursement of “non-covered payments” after closing. The purchase agreement at issue did not include such an obligation. In addition, the Chancery Court reasoned that even if there was a legal obligation to reimburse such expenses, the seller could recover against the target only given that the new parent company was an entity separate from the target.
BOTTOM LINE: If you want the parent to be obligated for the subsidiaries’ obligations, include it as a provision in the applicable agreement!
Two Or More Minority Stockholders Can Together Constitute A Control Group And Trigger Entire Fairness Review.
In In re Hansen Medical, Inc. Stockholder Litigation, C.A. No. 12316-VCMR, stockholders alleged that defendants, two stockholder who collectively owned more than 60% of the company, breached their fiduciary duty when they entered into exclusive stock purchase agreements with the acquiror and agreed to vote in favor of the merger in a squeeze-out merger. The Chancery Court found that the defendants functioned collectively as a control group and, as a result, it was conceivable that their actions were subject to the entire fairness standard. Specifically, the Court noted that the defendants were parties to a voting agreement for almost 25 years and were identified by the acquiror as the key stockholders with whom they needed to negotiate.
BOTTOM LINE: Consider carefully the relationship among two or more minority stockholders before determining that no controlling shareholder issues are triggered.
In In re Energy Transfer Equity, L.P. Unitholder Litigation, C.A. No. 12197-VCG, the partnership agreement at issue included a provision relating to the use of a conflicts committee to establish the fairness and reasonableness of a conflicted transaction. When the partnership raised the safe harbor as a defense against a partner’s challenge to the conflicted transaction, it was discovered that members of the committee were directors or officers of the general partners’ affiliates and the committee was never reconstituted properly. As a result, the protections of the safe harbor provision were not available.
BOTTOM LINE: Do not establish safe harbor provisions if the procedures necessary to benefit from them cannot be met or will be ignored.
In In re Tesla Motors, Inc. Stockholder Litigation, C.A. No. 12711-VCS, the Chancery Court considered the status of one of the acquiror’s minority stockholder in an acquisition. The plaintiffs alleged that the minority stockholder was a conflicted controlling stockholder because of his 29.1% ownership in the target as well as his 22.1% ownership in the acquiror and his influence in the acquiror. The Court found that a minority stockholder, who was the co-founder of the acquiror and its visionary, had tremendous influence on the Board’s decision-making process. As a result, the minority stockholder was a controlling stockholder notwithstanding his small percentage ownership in the acquiror. In turn, since a majority of the Board was not disinterested or independent of the controlling stockholder, the protections of Corwin did not apply.
BOTTOM LINE: Once again, context matters; do not assume Corwin will apply simply because there is no stockholder that owns a majority of the outstanding shares.
Compliance With DGCL Section 144 Safe Harbor Provisions Does Not Ensure Application of Business Judgement Rule.
In Cumming v. Edens, C.A. No. 13007-VCS, the Court of Chancery found that when the majority of the Board was not disinterested or independent, the transaction was subject to the entire fairness standard of review. This does not change simply because there has been compliance with DGCL Section 144 safe harbor provisions.
BOTTOM LINE: The contextual nature of whether or not a director is disinterested must always be considered!
In Appel v. Berkman, No. 316, 2017 , a stockholder alleged the Board breached their fiduciary duty when they failed to disclose why a director abstained from a vote to approve a tender offer. The Chancery Court dismissed the challenge and the Supreme Court reversed. The director at issue was the founder, Chairman of the Board and former CEO. He believed that the mismanagement of the Company negatively affected its sale price. According to the Supreme Court, it “[was] no common thing’ when a Chairman and founder abstain[ed] from voting on the sale of the business he founded…” and this information should have been shared with the stockholders.
BOTTOM LINE: Do not disclose that “[t]o the company’s knowledge, the Chairman of the Board of Directors has not yet determined whether to tender . . . his shares” when the minutes of the board meeting provide otherwise.
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.