“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.
The Court of Chancery addressed a claim for breach of fiduciary duty in connection with a going-private transaction that utilized the deal protections set forth by the Delaware Supreme Court in Kahn v. M&F Worldwide, Corp. The Court reiterated that the proper use of the Kahn protections makes it nearly impossible for minority shareholders to successfully claim breach of fiduciary duty against controlling shareholders or board members in a going-private transaction. The plaintiff’s only options are to successfully allege that the Kahn protections were not satisfied or that the transaction at issue constituted waste under Delaware law.
BOTTOM LINE: The business judgment rule will apply, and all but foreclose successful claims of breach of fiduciary duty, when (i) a transaction is conditioned on the approval of both an independent Special Committee of the Board and an informed majority of the minority stockholder vote; (ii) the Special Committee is empowered freely to select its own advisors and to say no definitively; (iii) the Special Committee meets its duty of care in negotiating fair price; and (iv) there is no coercion of the minority shareholders.
The plaintiff-stockholder sued the defendant-corporation seeking a declaration that a provision in a corporation’s bylaws was illegal. The provision at issue provided that directors could be removed by shareholders “for cause.” However, pursuant to Section 141(k) of the Delaware General Corporation law, stockholders may remove directors “with or without cause.” After the plaintiff filed for summary judgment, the defendant-corporation amended its bylaws to remove the relevant language, which mooted the action. In addressing the proper fee award in the mootness proceeding, the Court recognized that the bylaw provision at issue was not explicitly illegal, but was misleading to stockholders and could have a chilling effect on the exercise of their franchise under Section 141.
BOTTOM LINE: Shareholders have an absolute right to remove directors with or without cause. A bylaw provision that speaks only to removal of directors “with cause,” without mentioning the removal of directors “without cause,” is misleading and potentially illegal. A bylaw setting forth the process a shareholder may use to remove directors must be drafted to make clear that “cause” is not a requisite for such removal.
The Delaware Court of Chancery was asked to determine whether directors of a Delaware corporation (the “Corporation”) could be found to have individually breached a Shareholders Agreement (the “Agreement”) between the Corporation and its largest shareholder (the “Shareholder”) based on the directors’ signing the Agreement. The Court ruled that it was “clear from the face of the [Agreement]” that the directors did not sign the Agreement in their individual capacity, but rather signed the Agreement on behalf of the Corporation. As such, they were not party to the Agreement under Delaware law and could not be found to have breached its terms.
The Court also addressed a claim that the Corporation breached the Agreement by adopting a Plan of Dissolution to dissolve the Corporation. The plaintiffs argued that the Plan of Dissolution violated, among other provisions, a clause that stated that the Corporation “shall continue to exist and shall remain in good standing under the laws of its state of incorporation and under the laws of any state in which [it] conducts business.” The Court disagreed, stating: the clause “appears to be nothing more than a recognition by [the Corporation] that it will remain in good standing as a Delaware corporation. It speaks to a commitment to make necessary filings and pay required fees and expenses. It is a stretch to read more into the provision, particularly the commitment to exist ‘come what may’ that [the plaintiff] ascribes to it.”
BOTTOM LINE: If you wish a contract to be enforceable against a certain party, that party must sign the contract in its individual capacity. The fact that the individual has signed as a representative of another is simply not sufficient. Additionally, a standard representation that a corporation will remain in existence in good standing is not a prohibition of its dissolution or cancellation. In order to ensure such a restriction, specific representations must be carefully drafted and included in the relevant document.
Delaware Statutory Trust Act Trumped by Contract: Transactional Practitioners Must Consult Delaware LLC and LP Law when Drafting A Trust Agreement
The Delaware Court of Chancery was asked to determine whether the beneficial owner (the “LLC”) of a statutory trust (the “Trust”) had the right to inspect the books and records of the trust. The answer depended upon whether the Trust Agreement of the Trust incorporated the terms of 12 Del. C. § 3819, which authorizes restriction to access under certain circumstances. The Court determined that the Trust Agreement did not incorporate the restrictions permissible under § 3819, and, as a result, access could not be restricted. In so doing, the Court relied upon judicial precedent holding that a contractual books and records right in a limited liability company or limited partnership is independent of the relevant statutory right.
BOTTOM LINE: Like Delaware LLCs and LPs, Delaware statutory trusts may create rights under their Trust Agreements separate and apart from their statutory rights. In such instances, the relevant statutory rights will be inapplicable, assuming the Delaware Statutory Trust Act permits modification.
Informed and Uncoerced Shareholder Approval of a Merger Requires Application of the Business Judgment Rule to Post-Closing Monetary Damages Suits Not Involving a Conflicted Controller
The Court of Chancery applied the business judgment rule to dismiss the plaintiff’s post-closing monetary damages claims in connection with a challenged merger that was approved by a majority of disinterested, informed, and uncoerced shareholders. The Court stated: “[P]laintiff’s claims for post-closing damages against [defendant] directors and officers are subject to the business judgment presumption under the Delaware Supreme Court’s decision in Corwin v. KKR Financial Holdings LLC because of the legal effect of the stockholder vote, and that judicial review of plaintiff’s fiduciary duty claims (and related aiding and abetting claims) thus ends there.”
The Court of Chancery analyzed and refined the same principle in a separate opinion published one day after the court’s decision in the case above. In Larkin v. Shah, former shareholders of Auspex Pharmaceuticals, Inc. filed suit for post-closing monetary damages in connection with the 2015 acquisition of Auspex (the “Merger”), which was approved by a majority of Auspex’s disinterested shareholders. The plaintiffs alleged that the directors of Auspex breached their fiduciary duties by entering into the first all-cash deal they could land without regard for other superior offers. They contended that the Corwin decision, which held that the business judgment rule applies to “a transaction not subject to the entire fairness standard, that is approved by a fully informed, uncoerced vote of the disinterested stockholders,” did not apply to any transactions which are subject to entire fairness. The Court disagreed and found that the only transactions subject to entire fairness that cannot be cleansed by proper stockholder approval are those involving a conflicted controller. The Court concluded that because the Merger did not involve a conflicted controller, the Corwin decision applied and the business judgment rule was the appropriate standard of review.
BOTTOM LINE: The business judgment standard applies to transactions subject to enhanced scrutiny if a majority of disinterested, uncoerced stockholders approve the transaction unless the challenged transaction involves a conflicted controller. This application of the rule may not be rebutted. Therefore, if a Board of Directors discloses all information related to the conflict to minority shareholders and they approve the transaction anyway, the plaintiff-shareholders seeking relief must overcome the steep burden of the business judgment rule. The only practical way the plaintiffs will be able to accomplish this is by pleading facts showing the stockholder vote was not informed, was coerced, or that a conflicted controller was in fact at issue.
The Court of Chancery addressed an alleged shareholder’s claim to inspect the books and records of the defendant entity, Hybrid Energy, Inc. (“Hybrid”). The plaintiff claimed that Hybrid had issued him a stock certificate evidencing ownership of 1 million shares of Hybrid common stock. The plaintiff was also listed as a shareholder on Hybrid’s corporate stock ledger. However, at the time the plaintiff’s alleged stock certificate was issued, Hybrid’s Certificate of Incorporation authorized only 1,500 shares of common stock, all of which were already issued to someone other than the plaintiff. Nevertheless, the Court determined that the plaintiff’s name appearing on Hybrid’s share ledger was enough to create a rebuttable presumption that he was a shareholder entitled to inspect the books and records of Hybrid. The Court went on to find, however, that Hybrid had put forth enough evidence to rebut the presumption and the plaintiff was not entitled to access the books and records.
BOTTOM LINE: This case serves as a reminder that Delaware corporations must keep an accurate stock ledger and books and records in order to avoid numerous potential issues. The appearance of a name on a corporation’s stock ledger will create a presumption, only rebuttable by other evidence to the contrary, that the person so named is a shareholder of the company.
The Court of Chancery analyzed a claim for advancement made by a former computer programmer (“Aleynikov”) of Goldman, Sachs & Co., a subsidiary of The Goldman Sachs Group, Inc. (“Goldman Parent”). Despite not having any managerial or supervisory responsibilities, Aleynikov held the title of “Vice President.” He argued that he was entitled to advancement pursuant to the bylaws of Goldman Parent, which provided for advancement and indemnification to the “fullest extent permitted by law” to all directors and officers of any subsidiary of Goldman Parent. The bylaws defied “officers” of Goldman Parent subsidiaries to include “in addition to any officer of such entity, any person serving in a similar capacity or as manager of such entity.”
The Court analyzed the definition of the term “officers” in the context of the Goldman Parent’s bylaws and the Delaware General Corporation Law and concluded that Aleynikov should be considered an officer. The Court noted that “Goldman Parent and its subsidiaries created ambiguity about the scope of the officer designation by handing out the title ‘Vice President’ freely to their employees.”
BOTTOM LINE: An ambiguity in the unilaterally drafted organizational documents of a parent company will be construed against the Parent company. In order to protect itself from ambiguity and unintended liability, a parent company’s organizational documents that govern subsidiaries must align clearly with the policies and governance of those subsidiaries.
The Court of Chancery addressed the terms of a Merger Agreement executed in September 2015. Pursuant to the Merger Agreement, Energy Transfer Equity, L.P. (“ETE”), a Delaware limited partnership, would acquire The Williams Company, a Delaware corporation (“Williams”). Both ETE and Williams are substantial participants in the gas pipeline business.
As a condition precedent to the merger, Latham & Watkins LLP, counsel to ETC (“Latham”) was required to deliver a legal opinion to both parties to the effect that specific transactions within the merger agreement “should” be treated as a tax-free exchange under Section 721(a) of the Internal Revenue Code (the “721 Opinion”). The merger agreement required that ETC use “commercially reasonable efforts” to obtain the 721 Opinion, but failed to define the phrase “commercially reasonable efforts.”
In March 2016, after a significant decline in the energy market and the value of assets being transferred by Williams in the merger, Latham realized that it could not issue the 721 Opinion for tax-based reasons. In April 2016, Williams filed suit against ETC alleging that it had failed to use commercially reasonable efforts to obtain the 721 Opinion.
Although Latham was not named as a defendant, the Court began its analysis by ruling that Latham acted in good faith, noting that Latham devoted over 1000 attorney hours to determining whether the 721 Opinion could be delivered. Next, the Court determined that ETE’s efforts to obtain the 721 Opinion were commercially reasonable because they were “objectively reasonable” and there were no actions that ETC could have taken to make Latham issue the 721 Opinion.
BOTTOM LINE: The importance of choosing diligent and experienced counsel to issue closing opinions cannot be overstated. If the counsel requested to provide the opinion fails to exercise due diligence and determine in good faith whether it can or cannot provide the opinion post-execution of a merger agreement, the counsel’s client may be liable for failing to exercise “commercially reasonable efforts” to obtain the opinion.
The Court of Chancery addressed a class action suit which alleged a breach of the duty of loyalty by several independent, disinterested members of the Board of Chelsea Therapeutic International, Ltd. (“Chelsea”). The stockholders claimed the defendants acted in bad faith by knowingly selling Chelsea significantly below its standalone value, ignoring more favorable financial projections for the company, and instructing Chelsea’s financial advisors to ignore certain financial projections.
The Court of Chancery, noting that the application of bad-faith analysis was a “hazy jurisprudence,” rejected the plaintiffs’ arguments. The Court found that the plaintiffs had failed to state a bad faith claim, which requires “an extreme set of facts to establish that disinterested directors were intentionally disregarding their duties, or that the decision under attack was so far beyond the bounds of reasonable judgment that it seems essentially inexplicable on any ground other than bad faith.” The Court reasoned that the projections ignored by the defendants were “highly speculative” and the defendants’ choice to ignore them was not “without the bounds of reason.”
A limited partner (the “LP”) in a Delaware limited partnership (the “Company”) filed suit against the general partner (the “GP”) of the Company for breach of the Company’s Limited Partnership Agreement (the “LP Agreement”). The LP claimed that the GP failed to ensure that a conflicted transaction between the Company and the GP’s parent company was “fair and reasonable” as was required by the LP Agreement.
The Court of Chancery rejected the LP’s claim. The Court reasoned that the conflicted transaction was cleansed by the approval of a special committee under the terms of the LP Agreement, which stated:
“Any conflict of interest and any resolution of such conflict of interest shall be conclusively deemed fair and reasonable to the Partnership if such conflict of interest or resolution is (i) approved by Special Approval (as long as the material facts known to the General Partner or any of its Affiliates regarding any proposed transaction were disclosed to the Conflicts Committee at the time it gave its approval) . . . .”
BOTTOM LINE: In the alternative entity context, you must only agree to terms by which you are willing to be bound and you should always consult counsel as to the advisability and fairness of all terms. Delaware courts will enforce the terms of an alternative entity’s constitutional documents whether or not they are objectively fair.