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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.
Morris James Blogs
Showing 112 posts from 2008.
This decision has a good summary of the law governing certification of a class and when to approve a class settlement. Here the settlement permitted class members to opt out without the loss of any rights to pursue other related litigation. Thus, this decision distinguished the recent decision in Off v. Ross that had disapproved a settlement without opt out rights.
The interesting question is whether these two cases now mean that opt out classes are favored in Delaware. We doubt it. However, it is certainly the case that settlements with hardly any benefits to class members are receiving even greater scrutiny.
This important decision illustrates how hard it is to make an LLC agreement cover all future events. While there is a growing school of thought that advocates letting the parties make their own bed in the form of the LLC agreement, that approach fails to appreciate how hard it is to do that well. The failure to successfully do so leaves everyone unhappy, and they would have been better off had they not tried to begin with.
Here the parties to an LLC agreement tried to address conflict of interest situations that were sure to occur when the entity would contract with related entities owned by its directors. They did so by a clause that was supposed to limit fiduciary duties in such cases. What happened, and it happens a lot, is that the language they used did not exactly fit the circumstances they later faced. As a result, they proceeded apparently thinking that they were alright only to be followed by the Court correctly pointing out that the language they relied upon did not work as they thought. Now they face liability under fiduciary standards they cannot meet.
One answer is better drafting. But given the many times that seems not to have been done, perhaps it is time to give up the effort to speak to all future events. Instead, those transactions that are expected to occur should be addressed directly and specifically. If the directors want their personal company to rent to the LLC, then they should say that is okay at least if the rent is approved by an independent third party. If they do not know what type of transactions they want to enter into, then they should fall back on the extensive fiduciary law under the Delaware corporation law that will tell them how to do a deal safely.
It is now common to provide for post merger payouts and the arbitration of any disputes about those payouts. This case illustrates the problem of what happens when one party feels it does not have enough information to go into arbitration where discovery may be limited. The Court held that when the obligation to arbitrate is not conditioned on the receipt of information, arbitration will be ordered and the parties will be left to deal with the arbitrators over information exchange issues.
The answer is to provide clearly for adequate information exchange rights in the arbitration.
In this unusual case, the LLC sought to require the loser of a proxy contest to pay the costs. The LLC Agreement had a provision that imposed costs on those members who violated any of their obligations in the agreement. The LLC claimed that when the members put up unqualified candidates for office they should pay the costs of defeating them. The Court held that as the conditions to be a candidate were not obligations of the members, but "conditions," costs would not be imposed.
While the opinion does not say so, this may reflect a reluctance to discourage election contests by imposing costs on the loser.
The Court of Chancery rejected the proposed settlement of this derivative suit for two reasons. First, the transaction under attack in the litigation was completed after a modification favorable to stockholders before the settlement was presented for approval, the modification was considered by the board before suit was filed, and the transaction was not dependent on approval of the settlement. Thus, the Court concluded that there was no consideration for the settlement because the modification to the deal that plaintiff relied upon to justify the settlement would have happened anyway without the suit. A benefit received by stockholders that is not caused by litigation is not valid consideration for the settlement of the litigation.
In addition, the Court was troubled by the effect of the release that was part of the settlement on related litigation in New York. Given that the stockholders received virtually nothing for the release, it was wrong to affect their rights in the litigation elsewhere that might benefit them.
District Court Awards Punitive Damages Based in Part on Discovery Abuse, Denies Attorneys' Fees for Inadequate Proof
In this opinion the Court sanctioned the defendant’s conduct, including discovery abuse, by awarding punitive damages. The Court first entered default judgment against the defendant after his “repeated dilatory discovery conduct and his refusal to appear for deposition.” The plaintiff sought punitive damages in addition to compensatory damages, and the Court found that the entry of default did not preclude awarding punitive damages. The failure to appear for deposition was “but one example of the kind of willful conduct that requires an award of punitive damages.” The plaintiff also sought attorneys’ fees and expenses both for the Delaware action and proceedings in South Africa. The Court, however, denied this claim, finding that an award for fees in the South African litigation was unsupported by law, and the summary information submitted for fees for the Delaware proceeding was inadequate as a matter of law because it did not allow the Court to make a thorough analysis of the time records.
In a novel attempt to invoke the jurisdiction of the Court of Chancery, the plaintiff tried to rely upon Section 111(a)(2) of the Delaware General Corporation Law that provides the Court of Chancery jurisdiction in disputes over stock. Here the plaintiff was really seeking money damages for the failure to be paid the full value of his SARs. The court held this was a claim for money damages that it did not have jurisdiction to decide, not a claim over ownership of stock.
In this major opinion, the Court of Chancery held that a manager of a Delaware Statutory Trust has a fiduciary duty to the Trust absent a clear exclusion of that duty in the trust instrument. This conclusion has broad implications including that the owners of the manager may also have such duties in connection with transactions that arguably benefit the owner. That is consistent with a long line of Delaware case law in other contexts, such as for corporations and limited partnerships.
This once again illustrates the need for very careful drafting in these alternative entities where the governing instrument may set the rules of the game. Failure to do so means that principles of corporate law, or in this case, trust law, will control by default. That will defeat the whole purpose of using an alternative to the traditional corporate form to gain the right to draft rules for that particular transaction.
In this decision, the Court of Chancery again affirms it disinclination to stay proceedings in Delaware just because a federal securities case was filed first elsewhere. Some doubt about that issue may have existed after the Court did stay a Delaware case involving Bear Sterns in favor of federal litigation in New York. But as this opinion notes, the Bear Sterns case was unique.
This decision invalidates a provision in an unsigned LLC agreement for violating the statute of frauds. The Delaware LLC Act permits an oral LLC agreement; however, when the promise in that oral agreement cannot be performed within a year, the promise must be in writing. Given the common existence of oral LLC agreements, this decision sounds a word of caution.
A recent Delaware Court of Chancery decision has generated much discussion over whether disinterested directors may be held liable for approving a transaction that appeared reasonable to them and their advisors. Indeed, by holding that the directors may have acted in “bad faith,” the decision seemed to some to be a threat to the core principles embodied in the business judgment rule. That rule protects directors from being second guessed by courts long after the business decision has been made. These concerns are overstated. This article will: (1) outline the background to the current controversy over “bad faith” in Delaware, (2) predict how the Delaware Supreme Court will clarify the Delaware law of “bad faith” and (3) suggest a possible solution to address lingering concerns over director liability for disinterested business decisions.
For many years Delaware limited director liability for disinterested business decisions to those decisions properly held to be grossly negligent. This high standard seemed adequate to protect directors from inappropriate judicial second guessing. Then in 1985, Smith v. Van Gorkom held a board was grossly negligent. Many commentators felt Van Gorkom demonstrated the inability of courts to understand what should constitute gross negligence. The Delaware Legislature promptly responded to Van Gorkom by adopting Section 102(b)(7) of the Delaware General Corporation law. That new statute permitted Delaware corporations to include a provision in their certificate of incorporation that immunized directors for even grossly negligent decisions. Section 102(b)(7) has its exceptions, however. One of those is that actions “not in good faith” lose the statutory protection from liability.
As might be expected, if directors could not be successfully sued for actions “in good faith,” it was only a matter of time before plaintiffs filed claims alleging directors had acted in “bad faith”.
Bad faith remained largely undefined until 2005. After much debate regarding whether good faith was an independent fiduciary duty and what exactly constitutes good (and bad) faith, Chancellor Chandler defined bad faith as an “intentional dereliction of duty, a conscious disregard for one’s responsibilities” and a “[d]eliberate indifference and inaction in the face of a duty to act.” The Delaware Supreme Court then set out three different categories of fiduciary behavior that might deserve the “bad faith pejorative label.” The first, fiduciary conduct motivated by an intent to do harm, was aptly labeled “subjective bad faith” The second category involves “fiduciary action taken solely by reason of gross negligence and without any malevolent intent,” a lack of due care. The court decided, however, that gross negligence without more does not constitute bad faith, and thus does not breach the duty of loyalty. The third category is the Chancellor’s definition of bad faith, as intentional dereliction of duty, a conscious disregard for one’s responsibilities. In Stone v. Ritter, the court further stated bad faith is a “fail[ure] to act in the face of a known duty to act, thereby demonstrating a conscious disregard for [one’s] responsibilities,” and thus not exculpated under § 102(b)(7). More ›
Kempski v. Toll Bros., Inc., 2008 WL 4642633 (D. Del. Oct. 21, 2008)
In this opinion, the District Court reinforced Delaware’s law that indemnity provisions that require one party to indemnify another party for the second party’s own negligence are void as against Delaware’s public policy. Here the Defendant, Toll Brothers, Inc., contracted with Delaware Heating and Air Conditioning Services, Inc. (“DHAC”), to perform HVAC work on Defendant’s housing developments. One of DHAC’s employees was injured while performing the work, and sued Defendant. Defendant sought indemnification from DHAC pursuant to their contract. Both Defendant and DHAC sought summary judgment on the indemnification claim. The Court found that under Delaware law, the contractual indemnification provision that Defendant sought to invoke was against Delaware public policy, and granted summary judgment for DHAC. More ›
This decision has a good outline of when the right to sue a Delaware corporation expires after it is dissolved. The basic rule is that after three years no suit may be filed. Exceptions may exist for entities that still have undistributed assets and when a receiver is appointed for those entities.
This ninety-one page opinion is must reading on how to interpret a merger agreement and on the parameters of the obligation to proceed in good faith to close a deal. In upholding the obligation to at least try to obtain the financing to close, the Court goes into great detail on why the party seeking to escape its obligations bears a heavy burden to explain actions it has taken that may impede its ability to get financing or otherwise close a deal that it no longer finds attractive.
This decision repeats the settled Delaware law that the Court of Chancery will not appoint a receiver for a solvent Delaware corporation absent extraordinary circumstances. Of course, having a court tell the world that your tax evasion is not "extraordinary" justification for a receiver may have been punishment enough.