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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.
Morris James Blogs
For some time now, the Court of Chancery has told litigants that objections to documents requests should be specific, not generic and boilerplate. This decision thoroughly addresses the case law on this issue, with numerous citations to federal court precedent and detailed explanations of what objections are proper, including for claims of privilege. Oxbow should serve as a useful resource when it comes time to object to document requests in the Court of Chancery.
There is perhaps one single obligation that most aggravates corporate boards of directors: Paying your opponent's legal fees when you are convinced he has done you wrong. How then is that not just possible, but a regular occurrence?
Delaware law permits a corporation to agree to pay an officer or director's litigation expenses "in advance of the final disposition of such action, suit or proceedings." Persons considering serving on the boards of directors of a publicly traded corporation almost always insist that such "advancement rights" be provided to them, by contract or corporate bylaw. Thus, if their corporation later claims that the director acted improperly, such as by obtaining an unauthorized benefit or by deliberately neglecting her duties, that director will ask the corporation to pay for her defense.
Over the last few years, corporations have tried to avoid that obligation in many ways. For example, corporations have claimed they were fraudulently duped into hiring the defendant and therefore the advancement contract should be rescinded. More frequently, corporations have argued that the defendant's actions leading to filing suit did not "arise out the defendant's actions" as a director or officer (the commonly used qualifier in advancement contracts that must be met before fees are advanced). None of those defenses generally works, however.
Moreover, apart from the irritant of having to pay an allegedly "bad actor's" fees, the right to advancement often involves real money. The recent decision in White v. Curo Texas Holdings, Del. Ch. C. A. 12369-VCL (Feb. 21), involved an advancement claim for $5,121,651.73 and other decisions have involved similar large amounts. Under those circumstances, it is no surprise that corporations and other legal entities have sometimes resisted the advancement claims of their former directors or officers.
Once the advancement claim is denied, the claimant has the right to file suit in the Delaware Court of Chancery to compel payment, 8 Del. C. Section 145(k). Typically, that court will treat such a suit "summarily," meaning the litigation will be given priority on the curt's docket and scheduled for as prompt a hearing as circumstances permit. The Court of Chancery will then first determine if advancement is required. If so, then the parties will often be required to follow the procedures set out in Danenberg v. Fitracks , 58 A.3d 991 (Del. Ch. 2012) (the Fitracks procedures).
Briefly, the Fitracks procedures require that senior Delaware counsel for the parties review invoices for fees and expenses, meet to resolve any disputes and then no more frequently than quarterly, submit any still disputed amounts to the Chancery Court for its decision. In the meantime, the party who is required to pay advancement must pay at least 50 percent of the amount sought. Most significantly, the Court of Chancery's review is very limited with respect to what claims will be denied advancement. The Curo decision sets out in detail the limits of that review. Generally, only "grossly" overstated claims will be denied.
There are good reasons for limiting the Court of Chancery's scope of review in advancement cases. To begin with, advancements are subject to the claimant's providing "an undertaking to repay such amount if it shall ultimately be determined that such person is not entitled to be indemnified by the corporation," 8 Del. C. Section 145(e). That determination occurs after the litigation is resolved, such as by judgment or settlement. Hence, the corporation has some safeguard to get its money back if the claimant is judged not to be entitled to keep it. Moreover, as the Curo court reminded, it would be inappropriate to seek a granular review of the advancement claim while the underlying litigation continues for months or years. Accordingly, the court typically adopts the Fitracks procedures requiring the parties to first use their own efforts to avoid unnecessary waste of the court's limited resources. In fact, as Curo also points out, a party who inappropriately resists a claim despite using the Fitracks procedures may be required to pay the claimant's attorney fees incurred in pursuing the advancement claim.
Given the summary nature of advancement proceedings and the often lack of any effective client restraint on lawyers who are being paid by someone other than the actual client, there is a natural concern that the claims for fees are inflated. Moreover, even if the claimant has agreed to repay the fees if she loses, it is often doubtful that an individual has the unencumbered assets to do so, particularly if millions of dollars are involved.
This then finally brings us to the question of what can be done to avoid the perils of advancement obligations to former directors or officers. To some degree, those obligations can be insured against. A typical director and officer liability policy will reimburse a corporation that pays the legal bills of current or former directors or officers. For this reason, actual advancement cases are not all that common, compared to the number of suits filed against boards of directors.
Unfortunately, insurance does not always solve the problem. A typical D&O policy will exclude coverage for potentially collusive litigation, such as by denying insurance payments for "insured versus insured" suits. Thus, if the corporation is the plaintiff suing a former director, both the corporation and the director are considered an "insured" and there is no insurance coverage. This exclusion is not all that easy to avoid. Even stockholder derivative suits may be subject to the insured versus insured exclusion if the suit has been instigated by a director or by the corporation having a stockholder file the claim in her name.
Nonetheless, there are some potential ways to limit the perils of advancement. While the right to advancement will almost always be provided just as a matter of common practice, the right is essentially contractual. Hence, it may be subject to limitations set out in a contract or bylaw. Insurance companies have the same concerns as corporations providing advancement rights in terms of excessive fees unrestrained by the real client's oversight. To at least try to limit that exposure, insurers often retain the right to select counsel (with whom they have pre-existing reduced fee agreements) or to consent to settlements. While the designated counsel must be independent of the nonclient party paying his fees, it might be expected that the promise of future referrals will dim his ardor for fees. At least the counsel designated should be chosen on the basis of their experience and expertise and not a lawyer learning the substantive law at someone else's expense.
There have been few proposals on how to limit advancement claims. That may well be because that is no easy task given the strong demand for unlimited advancement rights. But if insurance companies can negotiate cost controls with their clients, perhaps corporations can also do so with their prospective and often highly paid directors.
This officer indemnification case arises out of one of the more sordid tales to appear in a Court of Chancery opinion and a later Delaware Supreme Court affirmance. This opinion, however, focuses on the less titillating but always intriguing question of whether the officer was sued by reason of the fact that he was an officer, as required to trigger indemnification rights.
This case involves the unfortunate deterioration of a marriage, as well as the couple’s winery venture, carried on through various LLCs. The decision illustrates the seriousness with which the Court of Chancery views the fabricating of evidence and the violations of its orders, including the status quo orders typically entered by the Court in control disputes. It also discusses interesting expert evidence on the subject of metadata used to prove the inauthenticity of certain electronic documents. In the end, the ill-behaving litigant was ordered to pay two-thirds of its adversary’s fees and expenses, as well as the expert witness fees and expenses.
When asked to choose the lead plaintiff and class counsel, the Court of Chancery applies the well-known Hirt factors. As this decision demonstrates, the Court also will place some significant weight on which of the competing plaintiffs used a books and records inspection to bolster its complaint, rather than just relying on the financial press.
Once the right to have fees advanced has been determined, the tricky issue is how to decide if the actual fees requested fall within the scope of the advancement rights. The Court of Chancery has adopted what is known as the Fitracks procedure, where the bills are subject to a meet and confer process with a set of rules to guide the outcome. This decision provides what may well be the definitive explanation of how that process is supposed to work, including how to resolve disputes at the advancement stage and what objections actually can be made to payment.
This decision addresses a fee-shifting provision in certain notes that would be triggered if any indebtedness evidenced by the notes was collected by legal action. In exchange for modifying the notes, the noteholders had negotiated for certain warrants. But the company failed to grant those warrants until it was forced to through a lawsuit. The warrants in effect created a debt under the notes, which the noteholders collected through a court proceeding. Thus, the fee-shifting provision was triggered.
Court of Chancery Holds That A Books And Records Plaintiff Must Be A Stockholder At The Time Of Suit
This decision resolved a matter of first impression: a plaintiff seeking corporate records under Section 220 of the DGCL must be a stockholder at the time he files his complaint to have standing. Thus, when a stockholder makes a proper Section 220 demand, and a merger terminates his ownership interest in the corporation before he files his books and records action, the now-former stockholder loses standing to sue. In short, stockholder-plaintiffs must be diligent in pursuing their record demands to avoid losing standing.
The case involves the issuance of certain convertible units offered to some, but not all, the limited partnership unitholders, and whether that offering and subsequent issuance violated provisions of the partnership agreement concerning distributions. While the Court of Chancery was unable to resolve the parties’ competing theories on summary judgment, the decision offers insight into how the Court will examine contractual distribution related claims in the alternative entity context.
The Court of Chancery often addresses the question of who, as between the Court and an arbitrator, should decide whether certain disputes are arbitrable. The analysis of this substantive arbitrability question is complicated where, as in this case, the parties’ relationship is governed by multiple contracts containing different choice of law, choice of forum, and dispute resolution provisions. In short, under Willie Gary, where the relevant contract generally refers all disputes to arbitration, and incorporates a set of rules for the arbitrator to follow, the arbitrator, not the Court, will decide substantive arbitrability. However, under McLaughlin, the Court still will not send the question of substantive arbitrability to the arbitrator where it is clear that only frivolous arguments support arbitration of a particular dispute.
This is another instance of the Court of Chancery addressing the overlap of advancement and the question of substantive arbitrability under Willie Gary. Here, the Court explains that once Willie Gary’s two-part test is satisfied and non-frivilous arguments exist in favor of arbitrability, the Court must defer the question of substantive arbitrability to the arbitrator. That the case is one involving advancement does not change the analysis.
This case involves the overlap of an advancement dispute and the question of substantive arbitrability under Willie Gary. The two-part test of Willie Gary asks whether the parties (i) generally referred all disputes to arbitration, and (ii) referred to a set of arbitration rules that empower an arbitrator to decide arbitrability. This decision focuses on the less clear question of what it means to generally refer all disputes to arbitration, and the effect carve-outs for certain disputes might have on this analysis. Broadly speaking, carve-outs must be expansive in order to prevent the question of substantive arbitrability from being passed onto the arbitrator.
Delaware law entrusts the management of a corporation to its board of directors. Not surprisingly, circumstances arise where a consensus among directors cannot be reached on major decisions impacting a company. In many cases, a board is composed of an odd number of directors, typically eliminating the potential for deadlock. However, where an even number of directors sit on a board, deadlocks can arise. In those situations, assuming certain statutory criteria is met, the Delaware Court of Chancery may appoint a custodian to act as a director and resolve the deadlock. More ›
This decision explains what “costs” are recoverable under Court of Chancery Rule 54 following a successful appeal. While the amounts involved normally do not merit much discussion, the cost of bond for an appeal can be significant when the court below awards a large judgment, like in this case. As this decision points out, the circumstances surrounding the posting of the bond may determine whether or not it was a “necessary” and therefore recoverable cost.
On the same day the Delaware Supreme Court affirmed the widely-reported TransPerfect decision, which ordered the sale of a successful company by custodian under Section 226 of the DGCL in order to break deadlock, the Court of Chancery issued this decision appointing a custodian of a Delaware corporation with limited powers to break a deadlock. The decision carefully explains the reason why a custodian should be appointed and why the custodian’s powers should be limited. In that sense, this is a “normal” custodian case not involving the very unusual circumstances the Court of Chancery had to deal with in TransPerfect.