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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.

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Showing 13 posts from November 2007.

Court of Chancery Dismisses Merger Claims

Posted In Case Summaries, M&A

Globis Partners LP v. Plumtree Software, Inc., C.A. No. 1577-VCP (November 30, 2007).

This decision explains why some attacks on a merger fail for want of a basis to avoid the business judgment rule and for a failure to make proper disclosure claims. The merger was a third-party transaction and the defendant directors received no unique benefit as a result. The Court held that granting those directors a right to indemnification, an acceleration of options and a cash out of vested options, did not constitute a special benefit that would make the directors interested parties. Hence, the business judgment rule applied.

The court also concluded that the complaint's disclosure claims lacked merit. For the most part, those claims were attacks on the merits of the investment banker's analysis attached to the proxy statement. That is not a claim of inadequate disclosure. Thus, the complaint was dismissed.

Court of Chancery Upholds Jurisdiction Over Nonresident Attorney

Sample v. Morgan, C.A. No. 1214-VCS (November 27, 2007).

In this major decision, the Court of Chancery has upheld its jurisdiction over a non-Delaware attorney who is alleged to have aided and abetted a breach of fiduciary duty by directors. Given the breadth of this decision, it has major implications for counsel to Delaware corporations.

First, the Court held that the attorney's arranging for the filing of a certificate with the Delaware Secretary of State satisfied the single act required to permit service of process on the attorney and his law firm under the Delaware Long Arm Statute. That is nothing new under Delaware law as other decisions have held that filing of such a certificate meets the statutory requirement for service.

Second, the Court held, in what may prove to be its most controversial decision, that Due Process was satisfied in subjecting the attorney to jurisdiction by a Delaware court. Noting that this "is a highly unusual case", the Court had no problem holding that giving advice on Delaware law and controlling the course of litigation in Delaware justified subjecting the attorney to jurisdiction here. What may prove to be controversial, however, are sections of the opinion that suggest that regularly providing advice on Delaware corporate law is sufficient to satisfy the requirement of Due Process in asserting jurisdiction over the non-Delaware lawyer for claims arising out of that advice.

Finally, the opinion holds that an attorney may be held liable for aiding and abetting a breach of fiduciary duty when he knows his advice is being used to carry out the breach. This is important because the knowledge requirement may be satisfied when the lawyer claims expertise in Delaware law and his advice is wrong. The inference then is that he knows his advice is wrong. While this seems to go too far, it is not clear how far the logic of the opinion may be stretched by other courts.

Superior Court Holds Date-of-Discovery Rule Does Not Toll Statute of Limitations in Legal Malpractice Action When Evidence Indicates Knowledge of Facts Relevant to Claim

Boerger v. Heiman, 2007 WL 3378667 (Del. Super. Oct. 31, 2007)

The three-year statute of limitations under 10 Del. C. § 8106, which begins to run at the time of the alleged breach in the case of a contract claim and at the time the injury occurs for a tort claim, may be tolled by, among other circumstances, the absence of observable factors that would place a layman on notice. This exception is called the date of discovery rule. When it applies, the statute of limitations begins to run when the defect is or should have been discovered.

In this legal malpractice action, the Superior Court held that the statute of limitations expired prior to the filing of the complaint and that it was not tolled because “multiple factors and plaintiff’s own statements indicate knowledge of the relevant facts which establish a potential claim . . . .” The plaintiff argued that the defendant attorneys fraudulently concealed his potential tax liability, but based on the evidence, the court concluded that the plaintiff should have discovered this fact, at the very least, by the time he hired an independent consultant who brought the matter to his attention. 

Supreme Court: When Standing is Closely Related to Merits, 12(b)(6) Applies, Not 12(b)(1)

Appriva Shareholder Litig. Co., LLC v. EV3, Inc., -- A.2d --, 2007 WL 3208783 (Del. Nov. 1, 2007)

Deciding whether a motion to dismiss based on lack of standing is considered under Rule 12(b)(6) or 12(b)(1) has implications and has divided some courts. First, lack of subject matter jurisdiction under 12(b)(1) is non-waivable and can be raised by the court sua sponte, whereas failure to state a claim under 12(b)(6) must be raised by motion. Second, a 12(b)(6) motion for failure to state a claim may be converted to a motion for summary judgment, considering matters outside the pleadings, but a 12(b)(1) motion may not. In this consolidated appeal, the Supreme Court held that when the issue of standing is closely related to the merits, a motion to dismiss for lack of standing is properly considered under 12(b)(6) for failure to state a claim.  More ›

Court of Chancery Limits Jurisdiction Over Officers

Ryan v. Gifford, C.A. No. 2213-CC (November 21, 2007).

In 2003, Delaware amended its long arm statute to cover corporate officers who served in that capacity after January 1, 2004. Past decisions under the director section of this statute have focused on when a defendant is subject to it for acts committed before the date the statute deems the defendant's holding a corporate office is consent to jurisdiction by a Delaware court. Consistent with that case law, this decision holds that prior bad acts do not constitute continuing wrongs that subject the defendant to Delaware jurisdiction after January 1, 2004.

Of course, the decision also holds that there are acts some of the defendants committed before that date which were further implemented after that date and that may subject them to jurisdiction. For example, receiving a back dated option before January 1, 2004 does not subject the officer to jurisdiction in Delaware unless after that date he commits further acts, such as concealing that the option was back dated.

Court of Chancery Extends Books And Records Inspection

Melzer v. CNET Networks, Inc., C.A. No. 3023-CC (November 21, 2007).

The scope of inspection rights may be affected by when a stockholder first acquired her stock. If the inspection is to investigate alleged wrongdoing, the rationale for granting inspection is to permit the filing of a derivative suit if the inspection shows that it is warranted. Hence, prior case law has held that inspection of records existing before the petitioner became a stockholder is not warranted because the stockholder has no right to sue for those pre-ownership wrongs under Delaware law.

This decision extends inspection rights when the potential claim is for a Caremark case alleging a "sustained or systematic failure" of oversight. Then, the Court held, showing past failures is relevant to showing a sustained wrong that culminated in damage to the entity after the petitioner became a stockholder. Under that rationale, the scope of inspection may extend to pre-ownership records.

Court of Chancery Holds Advancement Lost Despite Conversion

Posted In Case Summaries

Bernstein v. Tractmanager Inc., C.A. No. 7263-VCL (November 20, 2007).

This decision illustrates the perils in converting from an LLC to a corporate form without considering the consequences. Here, the LLC involved did not provide for mandatory advancement rights. The LLC was then converted into a Delaware corporation whose bylaws did provide for advancement as a matter of right. Quite possibly this was thought to be a good idea as the attorney who did the conversion was about to be sued by the entity and was a director who now thought he was covered. Unfortunately, the LLC did not provide for advancement and the Court of Chancery held that it was the LLC's operating agreement that controlled the right to advancement. Thus, advancement was denied.

The lesson here is that in converting from one form of entity to another do not assume that the new entity is obligated to fulfill all the obligations that might have been the responsibility of its predecessor. That was the losing party's argument. The problem was that the LLC was not obligated to him and thus, there was no liability to follow upon conversion. If you want the new entity to be liable then say so.

Supreme Court Upholds Preferred Stock Provision

Hildreth v. Castle Dental Centers, Inc., Del. Sup. C.A. No. 195, 2007 (November 15, 2007).

A tricky issue arises when a defective certificate of incorporation causes stock to be void. Here, the preferred stock was validly authorized but there was not enough common stock to fulfill the conversion rights of the preferred. The Supreme Court held that the defect was with the common stock, not with the preferred. Hence, one defect in the "contract" will not invalidate the whole contract.

Superior Court: No Ambiguity, No Extrinsic Evidence, No Dice

Dubuque v. Taylor, 2007 WL 3106451 (Del. Super. Oct. 1, 2007)

This case demonstrates that a Delaware court will not consider extrinsic evidence of the parties’ intent at the time of entering an agreement if the terms of the document are unambiguous.

The buyer/plaintiff purchased a transmission business called Goodeal Discount Transmissions of Dover, Inc., thinking it was a sole proprietorship. But after the closing, the franchisor—not the seller—came knocking on the buyer’s door seeking unpaid franchise fees and stating the amount to be paid going forward. Soon thereafter, the buyer sued the seller/former owner for breach of contract for failing to disclose that the business was a franchise, for breach of the contractual warranties, and for fraudulent misrepresentation.
More ›

Court of Chancery Upholds Objective Theory of Contract Interpretation

Seidensticker v. The Gasparilla Inn Inc., C.A. No. 2555-CC (November 8, 2007).

In this decision, the Court of Chancery has once again held that a contract means what it says, not what the parties say they subjectively intended. Thus, if the contract is unambiguous in its language, the Court will not accept explanations of what it was supposed to mean. Instead, the Court will enforce the contract as written. This opinion is useful for its review of recent case law that some have suggested adopted a "subjective" theory of contract interpretation under which, as the Cheshire Cat once said, "A word means what I say it means." Not so in Delaware.

District Court Finds No Ambiguity or Third Party Beneficiary Status, Grants Motion for Summary Judgment

MBIA Ins. Corp. v. Royal Indem. Co., 2007 WL 3125319 (D.Del. Oct. 25, 2007)

In this opinion the District Court resolved cross-motions for summary judgment on the defendant’s counterclaim for breach of contract. The relationship between the plaintiffs and the defendant arose out of the underwriting of student loans. Student Finance Corporation (“SFC”) underwrote loans to students using funds from banks, then allegedly fraudulently issued “forbearance payments” in order to hide delinquent and defaulting loans. SFC transferred the loans to several trusts, which then issued fixed income notes, called Certificates, to investors. Plaintiff #1 was the trustee of trusts holding the securitized student loans. Defendant insured the loans that backed the Certificates with insurance policies that unconditionally guaranteed the students’ repayment of principal plus 90 days interest. Plaintiff #2 guaranteed payment of the Certificates in the event that the Defendant failed to honor its policies on the loans. Plaintiffs sued Defendant seeking to enforce its unconditional guarantee to repay the loans. Defendant counterclaimed against Plaintiff #1 for breach of contract, arguing that Plaintiff #1 did not adequately fulfill its oversight responsibilities under applicable Pool Servicing Agreements (“PSAs”) with respect to the servicing of the loans, and thus did not discover the allegedly fraudulent forebearance payments, resulting in Defendant engaging in continual transactions with SFC. Plaintiffs’ claim for enforcement of Defendant’s guarantee obligation was settled, leaving the Court only Defendant’s counterclaim to resolve.  More ›

Court of Chancery Explains Limits of Requirements Contract

XO Communications LLC v. Level 3 Communications Inc., C.A. No. 2131-VCL (November 2, 2007).

While the actual terms of a contract will control its meaning, there are occasions when legal rules will determine the result of a contract dispute. Here, the Court of Chancery noted the rule that in the case of a requirements contract, it is bad faith for the buyer to produce for its own use the materials that it committed to buy from the other party  to the contract. The Court held that rule did not apply when at the time the requirements contract was entered into, the buyer had the means of producing the goods it had agreed to buy from the other party as well. In short, the requirement was not to use the producing party exclusively.

Court of Chancery Explains Fair Summary Rules

Posted In Case Summaries, M&A

In re Checkfree Corporation Shareholders Litigation, C.A. No. 3193-CC (November 1, 2007).

Exactly what needs to be included in a proxy statement for a merger vote seems to be a constant subject for debate. Only a "fair summary of the substantive work performed by the investment bankers" need be disclosed, not everything given to them. Moreover, when there is no competing bid, then to enjoin the merger the court must be convinced that a strong showing has been made of disclosure errors.