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Showing 7 posts from April 2011.

Court Of Chancery Sets Fee Guidelines

In Re Sauer-Danfoss Inc. Shareholders Litigation, C.A. 5162-VCL (April 29, 2011, revised May 3, 2011)

This will probably be the definitive decision on how to set the attorneys' fees in representative litigation where the benefit to the company and its stockholders is additional disclosures.  Not only does the decision explain how the Court will approach that issue, but it also contains a detailed table of fee awards in prior cases to serve as a guideline.


Court Of Chancery Explains Step-Transaction Doctrine

Liberty Media Corporation v. The Bank of New York Mellon Trust Company, N.A. , C.A. 5702-VCL (April 29, 2011) affirmed, Del Supr September 21, 2011. Both Section 271 of the DGCL and many indentures provide that a corporation may not sell all or substantially all of its assets without stockholder approval.  For years, a recurring problem has been how to apply that law to a series of asset sales that when taken all together amount to a sale of almost all the company's assets.  This decision explains the so-called "step-transaction doctrine" under which such multiple sales may be aggregated to be considered one sale requiring stockholder approval. The short [and probably too simplistic answer] is that when the sales each have their own business justification, the Court will not aggregate them. Share

The Song of Preferred Stockholders: 'You Get What You Asked for, Not What You Need'

Posted In News

Edward M. McNally
This article was originally published in the Delaware Business Court Insider | April 27, 2011.

For a number of years, private equity investors bought preferred stock as their investment vehicle. That this stock was considered equity rather than debt made it particularly desirable for startup companies that need to conserve their borrowing capacity. For the investors, preferred stock also might have a favorable tax treatment on the inevitable day when it was redeemed by the issuing company. All the investor had to do was provide sufficient protection for itself by the rights given to its preferred stock by the issuer’s certificate of incorporation. Seems simple enough.

Yet even the most sophisticated equity investors have failed to get what they actually need to protect their investment. They have asked for literally dozens of different rights as preferred stockholders, only to find out later that they failed to get what they really needed to secure the return of their investment. While it is true that in some cases preferred stockholders are also owed the fiduciary duties owed to common stockholders, that is not good enough. After all, they are "preferred." Why have they failed to protect themselves?

There are two basic legal principles that affect the ability of preferred stockholders to protect their investment. First, it is settled Delaware law that preferred stockholder rights are based on their "contract," what the company’s certificate of incorporation provides for the preferred stock. The courts will not grant them rights they did not get in the certificate.

Two recent Delaware decisions illustrate this principle. On March 29. in Fletcher International Ltd. v. ION Geophysical Corporation, the Chancery Court said the preferred stockholder sought to protect its investment by bargaining for the right to consent to the sale of any stock by a company’s subsidiary. In that way the parent company’s most valuable assets, its subsidiaries, could not be diluted without the preferred stockholder’s approval. But when the parent company wanted to do a deal that the preferred stockholder did not approve, the parent company just formed a new subsidiary and sold that subsidiary’s stock itself. Because the certificate of incorporation only prohibited a stock sale by a subsidiary and not by the parent company, the court permitted the sale to go forward over the preferred stockholder’s objection. No amount of complaining about form over substance did the preferred stockholder any good. It still lost.

SV Investment Partners v. Thoughtworks Inc., a Nov. 10, 2010, Chancery Court decision, reached a similar disappointing result for the preferred investor. There, the preferred stock had the right to be redeemed out of "funds legally available" on the redemption date. On that date the company had a "surplus" — its assets were worth more than its debts. However, the court ruled that the preferred was not entitled to be redeemed. It reasoned that because the company had legitimate needs for its cash, those funds were not "legally available" for redemption. In short, the precise wording the preferred stockholders asked for in the certificate of incorporation did not get them what they needed to be redeemed.

Getting around this first legal principle of strictly limiting the preferred’s right is not as easy as just giving it the power to elect directors upon default. For then the second legal principle that affects preferred stockholder rights comes into play. Directors have a fiduciary duty to all stockholders, even if those directors have been appointed just by the preferred stockholders. Hence, in the Thoughtworks situation, even if the majority of the directors had been elected by the preferred stockholders, they well may have had a duty to not use its funds for redemption when other uses of cash were better for Thoughtworks.

Indeed, recent Delaware decisions have criticized directors elected by preferred stockholders who wrongly favor the preferred stock. Because of those decisions, I suspect that it is the desire to avoid assuming any fiduciary duty to other stockholders that causes some private equity investors to not seek board control even if they are not timely redeemed.

What then are the remedies of the poor preferred stockholder left to only the terms of his or her preferred stock "contract" in the face of ingenuous schemes to work around his or her rights?

To begin with, the reality is that most of the time preferred stock ends up with the preferences it asked for at the bargaining table. Even if redemption may be postponed beyond the redemption date, steeply accruing post-redemption date carrying charges cannot be ignored forever. The price to be paid is just too steep, particularly if the company is to be sold to a third party or go public. Moreover, private equity investors learn quickly. The loopholes validated by past decisions will close in the next deal. The information exchange is just too fast to permit a clever avoidance tactic to be used for very long.

Finally, as the Thoughtworks decision points out, there are multiple existing ways a preferred stockholder may protect his or her investment. Requiring that redemption be paid by a short-term note, drag-along rights or even a forced sale of the company may all protect preferred stockholders. The vigilant preferred investor will remain as "preferred" as he wants, so long as he knows what to ask for in advance. Careful drafting is the key to the desired result.

Edward M. McNally ( is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group. He practices primarily in the Delaware Superior Court and Court of Chancery handling disputes involving contracts, business torts and managers and stakeholders of Delaware business organizations. The views expressed herein are his alone and not those of his firm or any of the firm’s clients.


Multi-Jurisdictional Litigation a Rich Vein of Issues for Chancery Court

Posted In News

Peter B. Ladig
This article was originally published in the Delaware Business Court Insider | April 20, 2011.

Settlements of multi-jurisdictional stockholder litigation challenging corporate transactions raise logistical and other issues for reviewing courts including the proper allocation of fees between and among competing plaintiffs.   Chancellor William B. Chandler III in In re Allion Healthcare Inc.  Shareholders Litigation recently addressed this problem and his opinion provides important guidance to practitioners.  Here, the problem was not the specter of a collusive settlement, as it was in the litigation arising out of the merger of Nighthawk Radiology Holdings Inc. (Nighthawk), previously reviewed in this space.

This time, the settlement was approved, but the counsel for plaintiffs in two different jurisdictions could not agree how to allocate the award of attorney fees between them, and required the intervention of the chancellor to resolve the dispute.  Not only is the chancellor’s analysis illuminating, he also used the opinion as an opportunity to suggest his preferred mechanism to address certain of the problems caused by multi-jurisdictional litigation.

On Oct. 18, 2009, Allion Healthcare Inc. (Allion) announced it had entered into an agreement contemplating a going-private merger transaction whereby Allion would merge with affiliates of private investment firm H.I.G. Capital LLC (HIG) and a group of Allion stockholders who together owned about 41 percent of Allion’s common stock. As a result of the merger, Allion’s unaffiliated stockholders would be cashed out for $6.60 per share.   In response to this announcement, lawsuits were filed in Delaware and other jurisdictions, including New York, alleging that the price to be paid in the merger was unfair and asserting claims of breach of fiduciary duty against Allion, its directors and HIG in connection with the merger.  The first lawsuit was filed in New York on Oct. 20, 2009. A week later, a lawsuit was filed in Delaware, followed by another lawsuit in Delaware filed by Steamfitters Local Union 449.

Defendants moved to stay the New York action in favor of the Delaware proceeding.  That motion was ultimately denied, but not before counsel for the plaintiffs in the Delaware action notified the Court of Chancery that the Delaware plaintiffs, New York plaintiffs and the defendants had reached an agreement for the defendants to supplement their proxy statement in exchange for the withdrawal of the motion for a preliminary injunction.

After the merger closed, the plaintiffs in New York and Delaware filed amended complaints.  Defendants filed motions to dismiss in both jurisdictions.  The motion to dismiss in New York was largely denied on Aug. 13, 2010, by which time the motion to dismiss in Delaware was fully briefed but not decided.

The parties to the Delaware proceeding began discussing settlement in August 2010, and informed the Court of Chancery in September that they had reached an agreement in principle to resolve the Delaware action.  The New York plaintiffs learned of the settlement of the Delaware action on the same day.  On Nov. 12, 2010, the parties to the Delaware action filed a stipulation of settlement providing for an additional $4 million to be paid to the unaffiliated stockholders of Allion.  The New York plaintiffs filed an emergency motion to intervene in the Delaware proceeding to either: (1) stay the action, (2) reject the proposed settlement, or (3) allow the New York plaintiffs to take discovery on the merits of the action and the proposed settlement.  The court denied that motion, finding that the New York plaintiffs were well aware of the settlement, and permitted the New York plaintiffs to object to the settlement at the hearing to approve the settlement.

At the hearing, the court approved the settlement and awarded attorney fees and expenses of $1 million: $250,000 for the improved disclosures and $750,000 for the improved merger consideration.  The court allowed counsel for the plaintiffs the opportunity to create a fee-splitting solution.  They were unable to do so, and the court was required to resolve the issue.

Suggesting an Approach

Before addressing the merits of the issue before it, the court noted that the issue of fee-splitting is another practical problem caused by multi-jurisdictional litigation.  While discussing generally the other issues created by multi-forum litigation, in footnote 12 to the March 29 opinion in In re Allion Healthcare Inc. Shareholders Litigation, the chancellor suggested his solution:

"My personal preference, for what it’s worth," the chancellor wrote, "is for defense counsel to file motions in both (or however many) jurisdictions where plaintiffs have filed suit, explicitly asking the judges in each jurisdiction to confer with one another and agree upon where the case should go forward. In other words … my preference would be for defendants to ‘go into all the courts in which the matters are pending and file a common motion that would be in front of all of the judges that are implicated, asking those judges to please confer and agree upon, in the interest of comity and judicial efficiency, if nothing else, what jurisdiction is going to proceed and go forward and which jurisdictions are going to stand down and allow on jurisdiction to handle the matter….’ Judges in different jurisdictions might not always find common ground on how to move the litigation forward. Nevertheless, this would be, I think, one (if not the most) efficient and pragmatic method to deal with this increasing problem.  It is a method that has worked for me in every instance when it was tried."

This pragmatic solution is typical of the Court of Chancery’s approach to many issues, both procedural and substantive.  Indeed, the notion that the judges hearing related matters should collectively determine where the matter should go forward is similar in concept to the suggestion by the special counsel in Nighthawk that all courts hearing a related matter should be made aware of events in the other proceedings.  While some momentum appears to be building toward this type of disclosure, counsel representing defendants in a similar position would be wise to heed the suggestions in Allion and Nighthawk even before more definitive guidance emerges.

Counsel Fees

Turning to the merits of the fee dispute, the court found the analysis straightforward.  The court found that the disclosure portion of the fee was appropriately split equally between the New York and Delaware plaintiffs.  Although the New York plaintiffs may have argued later that the disclosures were inadequate to support a settlement, they still contributed to the benefit achieved by the disclosures by independently negotiating for them.

Unlike the disclosure portion of the fee, the court found that the efforts of the New York plaintiffs did not contribute to the benefit achieved by the increased merger consideration, and awarded all of the $750,000 increased consideration fee to the Delaware plaintiffs.

In Delaware, the filing of a meritorious action followed by a benefit conferred to a class creates a rebuttable presumption that the benefit was caused by the litigation.   When similar lawsuits are litigated in multiple fora, the presumption of a causal relationship between the litigation and the benefit achieved applies only to the Delaware litigation.   Affording the presumption to all actions would encourage placeholder filings in other jurisdictions, wasting judicial resources and making it more difficult to reach a settlement.

Here, the New York plaintiffs did not sign on to the settlement or otherwise support it.   Thus, the only way the New York plaintiffs could merit a fee is if the New York litigation somehow caused the Delaware settlement.  Here, counsel for the New York plaintiffs argued that even though it played no direct role in negotiation of the increase of the merger consideration, it created an "atmosphere" where the Delaware plaintiffs were able to negotiate a resolution.  The court rejected that argument for many of the same reasons it has been rejected before — the impact on the Delaware litigation was purely conjecture and in the absence of sufficient evidence to the contrary, a settlement achieved by counsel for Delaware plaintiffs should be attributed to them.  The court also rejected the New York plaintiff’s argument that the denial of the motion to dismiss in the New York action "moved" the case along to encourage settlement, finding that the evidence presented at the settlement hearing refuted this argument.

The chancellor’s decision in Allion, along with the report of the special counsel in Nighthawk, provide invaluable guidance to attorneys counseling directors and corporations involved in multi-jurisdictional litigation with a Delaware component.  Those who counsel these groups would be wise to review these issues carefully when advising them.

Peter B. Ladig ( is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group.   He represents both stockholders and directors in corporate litigation.  The majority of his practice is in the Delaware Court of Chancery, although he has extensive experience in the other state and federal courts in Delaware and has been involved in over 50 published decisions.  The views expressed herein are his alone and not those of his firm or any of the firm's clients.


Court Of Chancery Enforces Scheduling Order

Posted In Discovery

Encite LLC v Soni, C.A. 2476-CC (April 15, 2011)

When the Court of Chancery establishes discovery deadlines, it is not kidding.  The Court is consistently generous with lawyers who need more time and ask for it for a good reason and ahead of deadlines.  But when the lawyer fails to ask until the deadline has passed, the Court is not so kind and, as here, may deny the request.


Are Directors Vulnerable for Lack of Oversight When a Natural Disaster Strikes?

Posted In News

Edward M. McNally
This article was originally published in the Delaware Business Court Insider | April 06, 2011
The recent events in Japan prompt the question of whether the members of a corporation’s board of directors have any exposure to liability when a natural disaster strikes their company. The potential claim would be that as part of their duty to oversee the company’s risk management, they should have better protected their company from the losses resulting from a natural disaster.

Of course, most people view such national disasters as "black swans," or events no one anticipates will happen.

Surely directors are not responsible for future events no one anticipates.

Or are they?

The analysis of this issue begins with a review of the directors’ duty to oversee their corporation’s activities to proactively prevent losses. In Delaware, this duty is often referred to as a "Caremark" duty, after the decision that proposed such a duty exists. Delaware courts have repeatedly described a Caremark claim as possibly the most difficult claim to win under Delaware corporate law. Yet, Caremark claims continue to be filed, albeit less frequently than other types of claims against directors.

A Caremark claim is particularly dangerous to directors. The Delaware Supreme Court has characterized some Caremark claims as breaches of the duty of loyalty that all directors and officers owe to their corporations. While that may not seem too different from a claim based on lack of care, the difference is significant.

The Delaware statute permitting a corporation to immunize directors from damages does not apply to breach of loyalty claims. Thus, director liability under a Caremark claim may have serious consequences if D&O coverage is not sufficient.

Regardless of whether the plaintiff characterizes the claims as a breach of the duty of loyalty or care, the claims will have one common characteristic. Typically, Caremark plaintiffs allege that the directors failed to take affirmative steps in some way that would have prevented damage to the corporation. That failure cannot be just simple negligence because under Delaware law, simple negligence is insufficient to constitute a breach of a director’s duty. Rather, at least gross negligence must be alleged to state a claim.

Thus, to state a Caremark claim the complaint usually alleges that the directors were aware of their duty to take action and that their failure to do so was grossly negligent. That awareness usually depends on "red flags" -- warnings the directors received before they failed to act. If the directors receive enough red flags and ignore them, then it may be said they were grossly negligent, and a Caremark claim exists.

However, the courts have also permitted a Caremark claim even without any red flags. When directors have utterly failed to do any monitoring of corporate affairs or put in place some system of supervision over corporate activities, a Caremark claim may be brought when damages occur because of bad conduct by employees. Directors just cannot simply sit back and do nothing, even in the absence of a warning that things are amiss.

Does it not follow that almost by definition a natural disaster is not anticipated because it is out of the ordinary and no red flags went up? That does not necessarily follow when you think about it. For example, it is reported that Japan had at least one prior earthquake that seriously affected a nuclear power plant. Japan has building codes that require earthquake protection. Does it follow that the past damage to a nuclear plant and the building codes generally together constituted red flags that directors of Japanese companies in the nuclear power business could not safely ignore? What do directors need to do to avoid liability for natural disasters?

In the final analysis, the answer to this question will depend upon what was reasonable under the circumstances. A large corporation may receive literally thousands of complaints each year from customers, employees or regulators. It is not reasonable to ask a board of directors to consider each of those complaints as red flags requiring their inquiry. The board would do nothing else if it had to look into a thousand complaints. Instead, what the board should do is have in place some process that is designed to catch wrongdoing, filter complaints and send to the board only those few that warrant further action by the board of directors.

That same analysis applies to the board’s duties concerning potential natural disasters. It is to be expected that some level of natural events may occur and lead to damages to a corporation’s infrastructure. Storms are even classified by how often they are expected to occur, with a "10 years storm" expected at least once a decade. The board should have in place insurance and other measures that it has been advised by experts are sufficient to protect their corporation from natural disasters that are reasonably likely to occur.

The board should periodically review the company’s insurance and disaster avoidance plans, at least to be satisfied that appropriate steps have been taken by management to address that threat to the company.

Not every potential disaster needs to be planned for, just those that are actual threats. If these basic steps are taken, directors should not be held liable if a natural disaster causes an anticipated harm to their company. We have not yet reached the point where the courts will expect directors to foresee black swans. Some risk is necessary for success. A properly functioning board is entitled -- and indeed expected -- by its investors to take such risks.

Edward M. McNally ( is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group. He practices primarily in the Delaware Superior Court and Court of Chancery handling disputes involving contracts, business torts and managers and stakeholders of Delaware business organizations. The views expressed herein are his alone and not those of his firm or any of the firm’s clients.



Delaware Superior Court CCLD Interprets Complex Contract

Textron Inc. v. Acument Global Technology Inc., C.A. 10C-07-103-JRJ CCLD (April 6, 2011)

The new Complex Civil Litigation Division of the Delaware Superior Court has attracted over 40 new cases because of its special  treatment of business disputes.  This opinion illustrates that Court will provide the careful treatment of contract disputes that is needed by the parties. Applying settled Delaware law to the issues presented, the Court denied a motion for judgment on the pleadings while providing the litigants guidance that may lead them to resolve their dispute. 

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