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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.
Morris James Blogs
Showing 12 posts from June 2008.
David P. Simonetti Rollover IRA v. Margolis, C.A. 3694-VCN (Del. Ch. June 27, 2008)
What must be disclosed to stockholders in a proxy for a merger vote is now well established. This decision again repeats that the interest of the investment firm giving a fairness opinion must be disclosed. Moreover, that does not just include its fees but also any gain it expects to make on the deal through its ownership of stock or other securities in the target.
London v Tyrrell, C.A. 3321-CC (Del Ch. June 24, 2008)
One of the tests for whether a board of directors is interested in a transaction under attack in a derivative suit so as to excuse demand on them before suit is filed is if they have personally benefited from the transaction. This decision makes clear that in the case of the grant of a stock option, the directors who have received the option will always be deemed interested in the outcome of an attack on that grant, even without showing the amount of the option is material to their financial condition.
Recently, whether outside counsel is entitled to advancement under a corporate bylaw that provides for payment of the fees incurred by “agents” has become a hot issue. When the attorney is acting as an “agent” depends on whether he is acting on behalf of the company in its relationship with a third party. Thus, an attorney who files litigation meets the test, but one who advises the company on a legal issue does not for lack of acting with a third party.
This somewhat odd distinction reflects a policy of restricting advancement of fees to attorneys who are expected to have the possible cost of litigation built into their fees and malpractice coverage.
There is a continuing tension between D&O insurers and the companies whose directors they insure to use the D&O coverage to pay for corporate transactions or, as in this case, for a settlement that no one but the company wants. In this decision the Court of Chancery has strongly upheld the right of former directors to refuse a settlement of litigation against both them and their company when they do not want to settle.
This decision arose out of the company's wish to have its former directors agree to liability in litigation that would then permit the company to sue the D&O carrier for the remaining insurance coverage and so-called bad faith failure to settle damages, all under a side deal that the company would not actually ask the directors to pay anything themselves. The former directors did not want to settle, however, particularly when the insurer also did not want to settle and was defending them under a reservations of rights letter that may have permitted the insurer to go after the directors for the fees advanced.
The Court determined the directors were entitled to the continued advancement of their attorney fees and fees for fees in this case as well.
Donohue v. Conning, C.A. 3733-VCS (Del. Ch. June 20,2008)
The Delaware Supreme Court has upheld a claim for fee advancement in litigation instituted by a former director, even though advancement has usually been thought of as a right to defense fees. This decision shows how limited that right may be when the advancement provision relied upon does not clearly provide for fees when the director starts the fight. For in such a case, the court held that there is no right to have fees advanced.
The decision has some unusual facts and may not cover another case were the director is clearly threatened with ligitaion and wins the race to the couthouse.
This decision offers predictability to parties entering into straightforward secured loan transactions under Delaware law. It assures that a security interest will not be treated as a conveyance of legal title. And, it prescribes that if a party intends for a transaction to result in the conveyance of rights to the secured lender greater than a security interest, then that party must set forth crystal clear and unequivocal language in the parties’ contract. More ›
In re Transkaryotic Therapies, Inc., C.A. 2776-CC (Del Ch. June 19, 2008)
The law of Delaware on when damages may be awarded for failing to make proper disclosures to stockholders in a proxy statement has been unsettled. This major decision resolves much of that uncertainty. The Court has now held:
“. . . this Court cannot grant monetary or injunctive relief for disclosure violations in connection with a proxy solicitation in favor of a merger three years after that merger has been consummated and where there is no evidence of a breach of the duty of loyalty or good faith by the directors who authorized the disclosures.”
The opinion carefully reviews and harmonizes precedent to reach this final conclusion. The net effect then is that the remedy for negligent disclosure violations is an injunction. Of course, as the opinion makes clear, damages may still be available in circumstances where there was a conflict of interest by the directors or they acted in bad faith. The latter would occur, for example, if the directors omitted substantial materials from the proxy statement deliberately to mislead.
Schuss v. Penfield Partners LLP, C.A. 3132-VCP (Del. Ch. June 13, 2008)
This decision explains how distribution rights for a withdrawing partner may be determined and points out that ambiguous language in the partnership agreement may lead to uncertainty. This was particularly important here as the withdrawing partner was given an in-kind distribution of these hedge funds securities after they had declined in value in the period after the date for determining the partner's share and the actual distribution date. This may become an important issue when the market is declining.
The Court also held that the plaintiff had stated a claim for breach of fiduciary duty by alleging the controlling general partner had selected the assets to go to the departing partner with the intent of hurting his interest.
Form bylaws taken from treatises or filings with the SEC are often copied without much thought. In this decision, the Court of Chancery warns that a very common set of those bylaws does not properly set out advancement rights for attorney fees. Hence, using that form without modification is now a sure way to lose those rights. Check out the form involved in this case and be sure to change it to more accurately reflect what is intended as to advancement.
Maitland v. International Registries, LLC, C.A. 3669-CC (Del. Ch. June 6, 2008)
It often occurs in a dispute between the owners of a closely held corporation or LLC that no one has enough votes to decide who should be counsel to the entity in the litigation. This decision explains how to deal with that problem. The answer is for the owner or group of owners who are not the plaintiff to intervene in the litigation to act on behalf of the entity. This avoids the tough issue of who pays the attorneys’ fees for the entity as the intervener pays her own counsel.
The District Court recently allowed claims for breach of the duties of care and loyalty against former directors and officers of Tectonic Network, Inc. (the “Company”) to go forward, rejecting Defendants’ jurisdiction, standing and insufficient claim arguments. Plaintiff, an Ad Hoc Committee of Equity Holders in the Company, sued Defendants for purportedly improper conduct in connection with the acquisition of three businesses and the resulting sale of one of the Company’s subsidiaries. Plaintiff alleged that Defendant Officers (Officer #1 and Officer #2) committed fraud related to the Company’s actions, and all Defendants breached their fiduciary duties. Specifically, Plaintiff alleged that the Defendants breached their fiduciary duties in recommending and/or approving the acquisition of the three businesses, all of which Officer #1 had a majority interest in. Plaintiff also alleged that the Defendant Officers committed fraud in making material misrepresentations to the board regarding the profitability of the acquired businesses and the prospective profitability of a future business plan that resulted in the sale of the Company’s subsidiary. Subsequent to acquisitions and sales, the Company’s financial picture worsened, and it filed for voluntary Chapter 11 bankruptcy. The Bankruptcy Court lifted the stay to allow Plaintiff to press its claims outside of the bankruptcy proceedings. More ›
For a director of a Delaware corporation to be guilty of gross negligence, her conduct must be so unreasonable that no one could have made the same decision. Unless the decision under review is this bad, it will be protected by the business judgment rule. This gross negligence rarely happens and it is thus difficult to find decisions that illustrate the type of conduct that meets this test. In fact, in this decision the defendant had a conflict of interest and thus the business judgment rule did not apply for that reason.
However, the Court went to great length to point out that the investment decisions under review did also exceed the gross negligence standard. This explanation provides an insight into what sort of decision-making is a breach of fiduciary duty. For example, in this case the investment was in a company that did not have a business plan, was continuously losing money, and was generally in such poor shape that no one but the hapless defendant would have lent it money. In short, it was gross negligence to make the loans and the defendant was liable for them as a result.