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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.
Morris James Blogs
Chancery Construes Sellers’ APA Contractual Representations Concerning Customer Relationships and Changes in the Business, Finds No Breach
This case serves as a cautionary tale when sellers’ representations in a purchase agreement fail to fully protect against the business risks in question. According to the Court, this approach encourages contracting parties to allocate risks and draft agreements with precision. This principle also aligns with Delaware’s pro-contractarian policy to enforce strictly the terms of parties’ agreements, especially when sophisticated parties at arm’s-length negotiate those agreements. More ›
Delaware law sets a high bar to sufficiently plead a Caremark claim for failure of board oversight, especially when the plaintiff must satisfy the heightened pleading requirements for establishing demand futility under Court of Chancery Rule 23.1. To overcome those hurdles, a plaintiff must plead with particularity that the board of directors either (i) utterly failed to implement any reporting or information systems or controls to address the risk that ultimately manifested, or (ii) having implemented such safeguards, consciously failed to oversee their operation and thereby disabled themselves from being informed of the risk that ultimately manifested. For either Caremark prong, the plaintiff must sufficiently plead bad faith, essentially that the directors knew they were not discharging their fiduciary duties. More ›
Chancery Finds Request for “Corrective Action” to be a Litigation Demand, Dismisses Derivative Claims for Failure to Plead Wrongful Refusal
Under the Delaware Supreme Court’s decision in Spiegel v. Buntrock, 571 A.2d 767 (Del. 1990), a stockholder who makes a demand upon the board to address potential wrongdoing concedes that the board may properly decide whether to cause the corporation to bring suit. That concession makes it more difficult to satisfy pleading standards in a later derivative suit. In this recent decision, the Court of Chancery reviewed the law in this area and concluded that – despite a disclaimer to the contrary – the plaintiff’s pre-suit letter was a litigation demand. More ›
Chancery Examines Partnership Agreement Allowing Deference to General Partner’s Decisions While Acting in its Individual Capacity and Instances in Which a Tortious Interference Claim can Extend to a General Partner’s Controllers
The Court of Chancery held that plaintiff former common unitholders failed to state a claim for breach of fiduciary duties in connection with the general partner’s alleged wrongful exercise of its call right to purchase all of the common units after the price of those units plummeted following the general partner’s public announcement of its intent to exercise the call right. The governing limited partnership agreement established different duties and standards of conduct depending upon whether the general partner was acting in an individual capacity or in an official capacity as the general partner. The Court reasoned that because the general partner was acting in its individual capacity in the exercise of its call right, the most deferential standard of conduct provided for in the partnership agreement, which eliminated the general partner’s duty to the limited partner common unitholders and the partnership, applied to this allegedly conflicted transaction. The Court noted that the plaintiffs’ request to apply the partnership agreement’s more heightened standard of conduct to the exercise of the call right misapplied Delaware Supreme Court precedent set forth in Allen v. El Paso Pipeline GP Co., L.L.C., 2015 WL 813053, at *1 (Del. Feb. 26, 2015). In Allen, the Supreme Court interpreted a nearly identical partnership agreement provision, and based on that provision, ruled that the general partner’s ability to act in its individual capacity “parallels the ability of a corporate fiduciary to exercise rights that are not held or exercised in a fiduciary capacity.” More ›
Chancery Refuses to Reform Operating Agreement to Impose Class Voting Requirements Not Contained in the Plain Language of the Agreement
The Court of Chancery held that plaintiff common unitholders of an LLC failed to state a claim for breach of the operating agreement and failed to adequately plead reformation in connection with their challenge to an asset sale that resulted in the senior preferred unitholder receiving the entirety of the sale consideration. Applying fundamental tenets of contract interpretation, the Court reasoned that the plain language of the operating agreement only required a majority vote of the combined total of preferred and common unit holders, and not a majority vote of each separate class of preferred and common unitholders, to approve the asset sale. The Court also rejected the plaintiffs’ claim for reformation to impose a separate voting class requirement that was contained in a term sheet that preceded the operating agreement, but was ultimately omitted from the final operating agreement. In analyzing the reformation claim, the Court relied upon West Willow-Bay Court, LLC v. Robino-Bay Court Plaza, LLC, 2009 WL 3247992 (Del. Ch. Oct. 6, 2009), in which the plaintiffs unsuccessfully sought reformation based upon a unilateral mistake that a contract amendment did not comport with a prior memorandum of understanding. The Court found that the common unitholders reformation claim was insufficient for the same reasons relied upon by the Court in West Willow-Bay: (i) the term sheet was not binding; (ii) even a cursory review of the voting provision in the operating agreement would have put the plaintiffs on notice that it differed from the term sheet; and (iii) it was not apparent that the voting provision in the operating agreement was unacceptable to the plaintiffs. Accordingly, the Court dismissed both the plaintiffs’ claim for breach of the operating agreement and their alternative claim for reformation.
Chancery Declines to Dismiss Second-Filed Delaware Action Because Delaware Forum Selection Clause Preempts McWane
Defendants brought an action in Montana state court against plaintiffs. Plaintiffs later filed this action in the Delaware Court of Chancery, alleging several claims that shared a common nucleus of operative facts with those asserted in Montana. Defendants moved to dismiss or stay the Delaware action under the McWane doctrine, which generally gives deference to a first-filed action in another jurisdiction and authorizes a dismissal or stay of a second-filed Delaware action. More ›
Chancery Rejects Claim that Books and Records Demand was “Pretextual,” Finds Sufficient Overlap Between Demand Letter and Plaintiff’s Purpose
A stockholder-plaintiff seeking a corporation’s books and records must have a genuine proper purpose, and cannot rely simply on a lawyer-crafted demand letter to justify her request. There must be alignment between a plaintiff’s books and records demand and her own stated interest in seeking books and records. In this recent decision, the Court of Chancery considers and rejects an attempt by a defendant-corporation to argue that a books and records demand was really driven by plaintiff’s counsel, and that the plaintiff lacked any genuine proper purpose. More ›
Delaware Supreme Court Provides Additional Guidance on Pleading Direct Claims Against Controllers and Control Groups
The Delaware Supreme Court affirmed the Court of Chancery’s dismissal of an alleged direct claim for dilution of the voting and economic interests of plaintiff stockholders because they failed to adequately plead that several venture capital firms constituted a “control group.” The Court began its analysis with a review of the standard for a controller or control group under Delaware law. In Gentile v. Rossette, 906 A.2d 91 (Del. 2006), the Court ruled that multiple stockholders can constitute a control group if they are connected in some legally significant way, such as by contract or other agreement, or working together towards a shared goal. The Court noted the guideposts that define a “control group” established by In re Hansen Medical, Inc. Stockholders Litigation, 2018 WL 3025525 (Del. Ch. June 18, 2018) and van der Fluit v. Yates, 2017 WL 5953514 (Del. Ch. Nov. 30, 2017). More ›
Superior Court Affirms Jury Verdict of Breach of Implied Covenant of Good Faith and Fair Dealing Concerning a Patent Dispute Settlement Agreement
This decision demonstrates the rare case where a breach of the implied covenant of good faith and fair dealing survived a legal challenge and resulted in a jury verdict in favor of the plaintiff. The case arose from a patent license and settlement agreement resolving a patent ownership dispute over the use of antibodies to treat Lupus. The 2008 settlement agreement gave ownership of the inventions to the defendants and obligated them to pay royalties to the plaintiff DRIT and its predecessor in interest. After paying the royalties for several years, in 2015, the defendants filed a request for a statutory disclaimer of the patent in question and notified the plaintiff that the disclaimer had the effect of eliminating any ongoing claim for royalties. This event was not addressed in the parties’ agreement, and the court in post-trial motions upheld the jury’s verdict in favor of the plaintiff on its implied covenant claim because the evidence supported findings that the defendants’ exercise of the disclaimer in these circumstances was an unusual event that the parties would not have reasonably anticipated, and the disclaimer was not a normal rational action and was taken solely for the purpose of discharging defendants’ royalty obligations. The Superior Court found that the defendants simply had not presented sufficient evidence to convince the jury that the defendants had a credible business justification for filing the disclaimer. The Superior Court also rejected a challenge to the testimony of plaintiff’s industry expert that the defendants’ rationale for use of the disclaimer fell outside normative, rational behavior in the circumstances. The court thus found that the jury reasonably could have found the defendants’ proffered justification to be pretextual and not credible.
Finally, the court granted damages in the form of royalties to DRIT from the time of the defendants’ breach to the date of the jury’s verdict, with a declaration of ongoing royalty obligations through the expiration of the patent. Going forward, the future royalty would be determined by the sales of the licensed drug. The court held that its ruling would uphold the expectation of the parties at the time of contracting, which was that DRIT would continue to receive royalties until the patent expired.
Chancery Denies Motion for Reargument, Finding No Change to Delaware Legal Principles for Existence of “Control Group” of Stockholders
Delaware courts recognize that a group of stockholders can constitute a “control group” when those stockholders “are connected in some legally significant way—such as by contract, common ownership, agreement, or other arrangement…” and work together toward a shared goal. Sheldon v. Pinto Tech. Ventures, L.P., 2019 WL 4892348, at *4 (Del. Oct. 4, 2019) (citing Dubroff v. Wren Hldgs., LLC, 2009 WL 1478697, at *3 (Del. Ch. May 22, 2009)). Under such circumstances, the control group stockholders may owe fiduciary duties to the corporation’s minority stockholders. Where a minority stockholder adequately pleads (1) the existence of a control group; and (2) a self-dealing breach of fiduciary duties by that control group, the minority stockholder’s claims may be both direct and derivative. Gentile v. Rossette, 906 A.2d 91, 99-100 (Del. 2006). In Silverberg v. Padda, Plaintiffs argued that they had alleged a direct claim by pleading that a control group of stockholders had breached fiduciary duties by approving alleged dilutive preferred stock issuances. After the Court dismissed this claim based on Plaintiffs’ failure adequately to allege a control group, as opposed to mere parallel action, Plaintiffs asserted in a motion for reargument that the Delaware Supreme Court’s recent Sheldon opinion had established a new legal principle to assess the existence of a control group. The Court disagreed, ruling that Sheldon had reaffirmed the Dubroff standard that the Court had applied in dismissing Plaintiffs’ claims. See Morris James blog post of October 14, 2019 (discussing the Court’s earlier decision). The Court re-affirmed its holding that Plaintiffs’ allegations did not suffice to allege a control group because the agreement between the allegedly controlling stockholders (1) did not relate to the challenged transaction; (2) included persons other than the purported control group members; and (3) did not bind the signatories with respect to their votes on the challenged transaction. Because the Court determined that Sheldon did not affect the Court’s holding that such allegations do not suffice to establish a control group, the Court denied Plaintiffs’ motion for reargument.
Shareholders of a Delaware corporation have a qualified right to access corporate books and records for a “proper purpose.” One such proper purpose is to investigate potential mismanagement or fiduciary wrongdoing. Indeed, Delaware law encourages shareholders to use this “tool at hand” prior to bringing a derivative action. But this type of inspection has an important precondition: the shareholder must advance some evidence to suggest a “credible basis” from which the Court can infer actionable wrongdoing. As this decision involving Facebook illustrates, the credible basis standard is lenient but not meaningless, and may turn on, among other things, the potential for monetary damages arising out of the alleged wrongdoing. After a trial on a paper record, the Court of Chancery denied an attempt by two stockholders of defendant Facebook, Inc. to obtain additional documents related to the company’s executive compensation practices. More ›
Delaware Supreme Court Finds an Insurance Policy Covering “Securities Claims” Did Not Apply to Claims for Violations of Common Law or Statutes Not Specific to the Regulation of Securities
The Delaware Supreme Court, applying principles of contract interpretation under Delaware law, held that claims of breach of fiduciary duty, unlawful dividends and fraudulent transfer were not Securities Claims reflecting a violation of any “regulation, rule or statute regulating securities” and hence the defendant’s director and officer insurance policy that covered such claims did not apply. The Supreme Court thus reversed a holding of the Delaware Superior Court that the insurance coverage applied because the claims “pertain[ed] to laws one must follow when engaging in securities transactions.” The Supreme Court held that the unambiguous plain meaning of the policy language was that the parties intended coverage only for claims arising under regulations, rules or statutes that “regulate securities.” Using that definition, the Supreme Court held that claims of breach of fiduciary duty, aiding and abetting fiduciary duty breaches, and promoter liability were not Securities Claims because they do not involve regulations, rules and statutes regulating securities. Likewise, the claim for unlawful dividends arose under statutes that regulated dividends, not securities, and the fraudulent transfer claims arose under statutes that were not “specific to transfers involving securities.” The Supreme Court rejected as overly broad Verizon’s interpretation that the phrase “regulating securities” included any “laws one must follow when engaging in securities transactions,” holding that that interpretation would encompass claims unrelated to securities and would render meaningless the limitation that coverage applied only to violations of rules or statutes “regulating securities.” The Supreme Court thus remanded the case to the Superior Court to enter judgment for the insurer-defendants.
Chancery Enters Sanctions in TransPerfect Litigation for Violating Exclusive Jurisdiction Provision in Court Order
This decision arose out of the dispute between once deadlocked co-owners of TransPerfect Global that played out in the Delaware courts over several years. That heavily-litigated controversy resulted in the appointment of a Custodian by the Court of Chancery and a forced sale of the company as part of a Final Order, with one of the co-owners, Phil Shawe, prevailing as the buyer. More ›
Chancery Finds Safe Harbor Conflicts Committee Not Validly Constituted in Master Limited Partnership Dispute
The Dieckman v. Regency GP LP matter has been in the Delaware courts for several years. The Court of Chancery originally dismissed the complaint attacking a conflicted merger transaction primarily on the ground that plaintiff had failed to plead that a unitholder approval safe harbor provision contained in the limited partnership agreement was inapplicable. The Delaware Supreme Court reversed, holding that plaintiff had adequately pleaded that unitholder approval was secured by false and misleading information and, further, that approval by a Conflicts Committee was tainted by conflicts involving its members. Plaintiff amended his complaint and, following briefing on a motion to dismiss, the Court of Chancery sustained plaintiff’s claim that the General Partner had approved the transaction even though members of its board did not believe that the transaction was in the best interests of the limited partnership. More ›
Chancery Denies Former Derivative Plaintiff Standing to Challenge Merger That Extinguished Derivative Claims
When a stockholder derivative claim is extinguished in a merger, the former derivative plaintiff may have standing to contest the merger directly on the ground that the entity’s fiduciaries permitted a material litigation asset to be extinguished in the merger process without value to the stockholders. In the well-known precedent In re Primedia Stockholders Litigation, 67 A. 3d 455 (Del. Ch. 2013), the Court of Chancery established a three part standing test: 1) Was the underlying claim viable? 2) Was its value material in light of the merger consideration? 3) Did the company fail to receive value for the claim in the merger because the buyer would not be willing to pursue it? Applying this test, here the Court ruled that the former unitholder and derivative plaintiff lacked standing to attack the merger and dismissed the claim. More ›