Delaware Corporate and Commercial Case Law Year In Review – 2017
Morris James attorneys Lewis Lazarus, Albert Manwaring and Albert Carroll authored an article published in Transaction Advisors titled Delaware Corporate and Commercial Case Law Year in Review – 2017. The article summarizes ten significant decisions of the Delaware Supreme Court and the Delaware Court of Chancery over the past year, including matters such as appraisal rights, duties in the master limited partnership context, director compensation awards, and preclusion in shareholder derivative litigation. Continue reading for the full article.
This top ten list summarizes significant decisions of the Delaware Supreme Court and the Delaware Court of Chancery over the past calendar year. Our criteria for selection are that the decision either changed the law in a meaningful way or provided clarity or guidance on issues relevant to corporate and commercial litigation in Delaware. We introduce the decisions in no particular order, and have grouped some complementary decisions together as one. The list does not include every decision of significance, but is intended to provide litigants and litigators with an array of decisions on varied issues likely to affect business dealings or business litigation
One: DFC Global Corporation v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017) (Strine, Chief Justice); Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd., --- A.2d ----, 2017 WL 6375829 (Del. Dec. 14, 2017) (Valihura, Justice)
Delaware law makes available so-called appraisal rights for stockholders under certain circumstances, which means a statutory process allowing them to forgo a merger’s financial consideration in favor of a judicially-determined appraisal of “fair value.” Delaware courts have long made clear that the deal price for a company, while relevant, does not necessarily equate to the “fair value” that petitioners are entitled to receive in an appraisal proceeding. A string of recent Court of Chancery decisions, however, adopted the deal price as fair value, reinforcing the view that the market price for an arm’s-length transaction achieved after a thorough sale process likely will be the best evidence of fair value. Two decisions in mid-2016 arguably departed from this line of cases by setting fair value above the deal price without affording the deal price significant weight despite reasonably thorough sale processes: DFC Global and Dell. Each did so on different grounds. DFC Global’s departure from the deal price turned on company turmoil and regulatory uncertainty that raised questions in the Court of Chancery’s mind about the reliability of the deal price and management’s financial projections. Dell’s departure principally turned on the transaction being a management buyout, with the only active bidders being financial (rather than strategic) buyers, as well as the Court of Chancery’s perception of a valuation gap between the pre-deal stock price and the company’s intrinsic value because of investors’ myopic short-term views. Both decisions were widely-reported, hotly-debated, and appealed to the Delaware Supreme Court.
The first shoe dropped with DFC Global. The Delaware Supreme Court reversed the Court of Chancery and clarified the appropriate role of the deal price in a truly arm’s-length transaction achieved after a well-structured sale process with no self-interest affecting the market check. In short, while there is no presumption in favor of the deal price, it is the best evidence of fair value under the right circumstances. The decision addresses other issues as well, such as the effect regulatory uncertainty or internal rate of return targets set by the bidder should have on the trial court’s analysis (a factor relevant in Dell, and a signal of what was to come). The other shoe dropped four months later, with another reversal by the Supreme Court in Dell. That decision espouses the same principles as DFC Global and more, but in the context of management led buyouts. Together, DFC Global and Dell provide context as to when a deal price should represent strong evidence of fair value in the Court of Chancery’s analysis.
Key takeaway: While there is no presumption in favor of the deal price in appraisal litigation, it is the best evidence of fair value in a truly arm’s-length transaction achieved after a well-structured sale process with no self-interest affecting the market check. Under these decisions, appraisal petitioners likely will need to demonstrate significant flaws in the sale process or compelling evidence of a market failure to overcome the substantial weight afforded to the deal price in arm’s-length deals with robust market checks.
Two: Brinckerhoff v. Enbridge Energy Company, 159 A.3d 242 (Del. Mar. 20, 2017; revised Mar. 28, 2017) (Seitz, Justice)
Agreements for limited partnerships, in particular for publicly-traded master limited partnerships (MLPs), are notoriously complicated and often hard to understand, so much so that two of the state’s judges co-wrote a detailed article calling for more standardization in this area. One consequence is that general partners in the MLP context may find themselves exposed to potential liability for decisions, from which they thought the partnership agreement protected them. Partnership agreements for MLPs often purport to eliminate common law fiduciary duties, replace them with a contractual duty to act in “good faith,” and provide safe harbors for transactions involving a conflict (a common occurrence in the MLP context).
This decision features several significant takeaways. First, the Delaware Supreme Court held that the partnership agreement’s general “good faith” standard of care for the general partner does not displace specific affirmative obligations contained in the agreement’s other provisions. Thus, breaching a requirement that a conflict transaction be fair and reasonable to the partnership is still a breach, even if it was in good faith. Second, the decision holds that even when the partnership agreement provides exculpation for damages claims, equitable remedies remain available. Thus, for example, if the MLP’s general partner carries out an unfair transaction with the partnership, a court may consider rescission or reformation even when the general partner is protected from monetary liability. Third, the decision lowers the pleading standard for asserting a claim of bad faith in this context (i.e., failing to meet the contractual duty of good faith). A test applied previously was whether the transaction essentially constituted “waste”—a stringent test requiring a deal so bad that no rational person would have approved it. The new pleading standard adopted by the Supreme Court is less stringent. The allegations only must support an inference that the general partner did not reasonably believe its decision to be in the partnership’s best interests.
Key takeaway: Brinckerhoff provides significant protections for limited partners in the MLP context, at least for MLPs with similar contractual terms (since there may be room for drafting around some of these protections). The decision is required reading for drafters of MLP agreements, as well as general partners and their advisors when considering a conflict transaction.
Three: In re Investors Bancorp, Inc. Stockholder Litigation, --- A.3d ----, 2017 WL 6374741 (Del. Dec. 13, 2017) (Seitz, Justice)
Decisions by directors with respect to their own compensation are inherently self-interested. By default, Delaware law subjects such decisions to heightened scrutiny upon a challenge (i.e., the entire fairness standard of review). Under the doctrine of stockholder ratification, Delaware law generally permits stockholders to approve conflicted transactions, like director compensation decisions, invoking the protections of the business judgment rule for the decision makers. Delaware precedent had developed so that directors could raise a ratification defense if they made the at-issue compensation decision pursuant to a shareholder-approved compensation plan that imposed meaningful, specific limits.
This decision overrules that precedent. At the trial court level, the Court of Chancery had applied the typical rule and dismissed a compensation challenge where the stockholders had approved an equity plan with sufficient limits to infer ratification. On appeal, the Delaware Supreme Court reversed and handed down a new rule, greatly limiting a ratification defense in the director compensation context. Under the new rule, even where stockholders have approved a director compensation plan, the board’s compensation decisions will not be protected by the business judgment rule unless (1) the stockholders specifically approve the at-issue director award, or (2) the plan is self-executing and removes all discretion, such as using a predetermined formula. Thus, when stockholders have approved an equity incentive plan that gives the directors discretion to grant themselves awards within general guidelines, and a stockholder sufficiently alleges that the directors inequitably exercised that discretion, then the ratification defense is unavailable to obtain a dismissal, and the directors have to prove the fairness of the awards to the company.
Key takeaway: While compensation entirely fair to the corporation still will be upheld, discretion-based director compensation is at risk without a record to support the fairness of the award. To obtain business judgment review in any challenge to director compensation, practitioners should ensure that equity incentive plans are self-executing and contain a predetermined formula for calculating director compensation.
Four: Wilkinson v. A. Schulman, Inc., 2017 WL 5289553 (Del. Ch. Nov. 13, 2017) (Laster, Vice Chancellor)
Some entrepreneurial plaintiff-side corporate law firms advertise that they are “investigating” matters following a corporation’s announcement of some misfortune. Their purpose is to attract a stockholder as a client and use that client’s status as a stockholder of the relevant corporation to bring suit or, often, to first demand an inspection of the books and records the firm needs to support a well-pled complaint using Section 220 of the Delaware General Corporation Law.
Section 220 generally permits stockholders to inspect corporate books and records when they are motivated by a “proper purpose” under the law, i.e., one reasonably related to the person’s status a stockholder. Ulterior motivations usually do not matter, so long as the stockholder’s primary purpose is a proper one. Further, investigating mismanagement qualifies
as a proper purpose, so long as the stockholder has a credible basis for suspecting mismanagement.
This action involved a books and records demand regarding the board’s decision to grant additional compensation to its departing chief executive. Investigating mismanagement surrounding such a decision could qualify as a proper purpose. However, the Court of Chancery denied inspection for lack of a proper purpose following a trial, finding that the demand was in fact a lawyer-driven effort and the client had no real interest in the issues that the law firm wanted to investigate. In other words, the advanced purposes were not the client stockholder’s actual purposes, and thus, he lacked a proper purpose as the plaintiff stockholder.
Key takeaway: While the result here probably could have been avoided by a better informed client, this decision could have far-reaching consequences. It is not uncommon for plaintiff-shareholder lawsuits, including books and records cases, to be lawyer-driven.
Five: In re Wal-Mart Stores, Delaware Derivative Litigation, 167 A.3d 513 (Del. Ch. July 25, 2017) (Bouchard, Chancellor)
One issue particularly relevant in an era of proliferating shareholder derivative litigation across multiple fora is preclusion in one forum based on the dismissal of an earlier or quicker moving suit in another forum. The accepted approach in Delaware, like most jurisdictions, involved examining the “adequacy of representation” provided by the plaintiffs in the dismissed action. So long as the representation was adequate, i.e., not “grossly deficient,” dismissal was likely in the second suit.
In this case, the Court of Chancery originally applied the typical adequacy of representation test and dismissed the Delaware action based on a quicker moving suit’s dismissal elsewhere, where the plaintiff failed to sufficiently plead that pre-suit demand on the board was excused. On appeal, the Delaware Supreme Court remanded the action, directing the Court of Chancery to determine whether its analysis raised a federal due process concern.
Considering the issue afresh on remand, the Court of Chancery advocated a new test governing preclusion in derivative litigation. According to this new test, just because one derivative litigation was dismissed for failure to overcome the requirement of a pre-suit demand on the board, it does not mean a similar derivative suit must be dismissed on the same grounds. Instead, an earlier dismissal should only affect the second suit if the first suit was dismissed after (i) the plaintiff survived a demand futility motion or (ii) the board conceded that demand is excused. Only at one of those points would the plaintiff in the first suit be acting on the company’s behalf, with its actions capable of binding other derivative plaintiffs who are trying to act on the same company’s behalf. Originally stated as dicta in In re EZCORP, Inc. Consulting Agreement Derivative Litigation, 130 A.3d 934 (Del. Ch. 2016), this rule, among other things, prevents ill-prepared and typically rushed derivative complaints from cutting off better-prepared complaints.
Key takeaway: It remains to be seen whether the Delaware Supreme Court will adopt the bright-line EZCORP rule as endorsed by Wal-Mart. If it does, such preclusion defenses will be much more limited. Either way, corporations can engage in some self-help by adopting Delaware forum selection bylaws with the goal of funneling most stockholder litigation to a single forum.
Six: In re Martha Stewart Living Omnimedia Inc. Stockholder Litigation, 2017 WL 3568089 (Del. Ch. Aug. 18, 2017) (Slights, Vice Chancellor)
Transactions involving conflicted controllers are among the most suspect under Delaware law when challenged. By default, they are subject to heightened scrutiny, i.e., the entire fairness standard of review. But, Delaware law provides options for conflicted controllers who wish to avoid the rigors of the entire fairness test. Under the Delaware Supreme Court’s seminal decision in Kahn v. M&F Worldwide, 88 A.3d 635 (Del. 2014), conflicted controllers can not only avoid the burden of proving entire fairness, but also they can secure Delaware’s most lenient standard of review, i.e., the business judgment standard of review.
To gain this powerful litigation advantage under M&F Worldwide, the controller needs to establish two procedural protections for the minority stockholders. It must, from the outset of the transaction, condition the deal on: (i) negotiation and approval by a special committee of independent directors, free to select their advisors, empowered to say no, and who fulfill their duty of care, and (ii) approval by an uncoerced, fully-informed majority-of-the-minority stockholder vote. Compliance with M&F Worldwide limits plaintiffs to untenable waste claims, and should result in an early dismissal.
Prior to this decision M&F Worldwide had been applied to situations where the controller was the buyer in a squeeze-out merger. This decision extends M&F Worldwide to circumstances where the controller is a seller, and might have engaged in a conflicted transaction based on different consideration or unique benefits. As noted, the dual protections of M&F Worldwide must be adopted at the outset of a conflicted controller transaction to be effective. This situation with a seller is slightly different. The protections need only be adopted as soon as the controller is to become part of the negotiations with the third-party acquirer. If timely adopted (and followed), business judgment should be the standard of review.
Key takeaway: By extending M&F Worldwide to seller conflicted controller transactions, this decision affords protection to not just controllers, but also those acquirers who might need to negotiate unique benefits with the controller to obtain the deal they want, while hoping to mitigate litigation risk.
Seven: The Mrs. Fields Brand Inc. v. Interbake Foods LLC, 2017 WL 2729860 (Del. Ch. June 26, 2017) (Bouchard, Chancellor)
A material adverse change or effect clause permits a party to avoid its contractual obligations under certain circumstances. Delaware courts have addressed so-called “MAC” or “MAE” clauses in the merger agreement context on a number of occasions. Under that precedent, the party claiming a material adverse change has a high burden of proof. Basically, to constitute a material adverse change, the adverse change to a company’s business must be unexpected, seriously affect the company’s financial health, and extend over a significant period of time. A short-term hiccup in earnings will not suffice. This decision is notable because it largely extends this stringent test to the commercial contract context, here a baked goods license agreement with a “materially adverse” occurrence provision.
Key takeaway: Commercial contract drafters should take note of this decision. If you are looking to establish a lower threshold to avoid certain obligations, it might make more sense to use firm facts or figures, rather than a non-specific material adverse change clause.
Eight: Gramercy Emerging Markets Fund v. Allied Irish Banks, P.L.C., --- A.3d ----, 2017 WL 4857141 (Del. Oct. 27, 2017) (Strine, Chief Justice)
Courts have the discretionary power to decline to hear a case when another court, or forum, is better suited to do so, a doctrine referred to as forum non conveniens (i.e., an inconvenient forum). In this decision, the Delaware Supreme Court sets a new standard under a forum non conveniens analysis and clarifies the spectrum of forum non conveniens standards available in Delaware.
Under the so-called Cryo-Maid factors, a Delaware court may dismiss a suit on forum non conveniens grounds if the defendant shows that litigating in Delaware would impose overwhelming hardship. That is a plaintiff-friendly standard. The analysis is different when the Delaware action is not the first-filed suit on the subject matter, i.e., Delaware was not the parties’ first choice of forum. Under the so-called McWane doctrine, when a sufficiently identical suit already is pending elsewhere, a Delaware court has discretion to dismiss or stay the later-filed Delaware action. McWane does not require that the defendant face overwhelming hardship and thus is the more defendant-friendly standard.
This decision deals with a particular convergence of Cryo-Maid and McWane. What should a Delaware court do when the first-filed suit elsewhere is procedurally dismissed and thus no longer pending? Is a motion to dismiss for forum non conveniens in a later-filed Delaware action still subject to the more plaintiff-friendly overwhelming hardship standard using the CryoMaid factors, or does the more defendant-friendly McWane standard apply instead? This decisions rules that neither standard applies. Rather, the Delaware Supreme Court establishes an intermediate standard. In short, in such a situation, the Cryo-Maid factors relevant to a showing of overwhelming hardship should control the analysis. But, those factors must only favor a dismissal, rather than establish overwhelming hardship to the defendant.
Key takeaway: Following Gramercy, choosing to file a suit outside of Delaware that ends in a procedural dismissal is of greater consequence to the plaintiff, who might find his Delaware action dismissed under a forum non conveniens analysis even though the defendant does not establish overwhelming hardship.
Nine: Nguyen v. View, Inc., 2017 WL 2439074 (Del. Ch. June 6, 2017) (Slights, Vice Chancellor)
Nobody is perfect. Mistakes happen. Sometimes a corporation intends to do some act, but there is a defect in its process, such as failing to comply with an applicable provision of the Delaware General Corporation Law or the corporation’s governing documents. In the past, such mistakes have had negative consequences disproportionate to the error. So, a few years ago, Delaware enacted Section 204 and 205 of the DGCL. Those statutory sections provided mechanisms for a corporation to ratify defective corporate acts or seek relief from the Court of Chancery to validate a defective corporate act. They are useful tools, but there are limitations, as this decision explains.
The underlying facts of the case are rather unique, involving a controlling stockholder and founder’s ouster from the company, followed by a settlement agreement contemplating a preferred stock financing, but with a subsequent timely revocation of the settlement. The end result was that the preferred stock financing was disapproved by the controlling stockholder. The company attempted to ratify the financing under Section 204. In the ensuing litigation, the Court of Chancery denied the company’s motion to dismiss based on ratification. In doing so, the Court laid down an important limitation on the statute: an “unauthorized” corporate act, disapproved by a majority vote, is not a “defective” corporate act capable of ratification. Such an act was not, as required by the statute, within the company’s power at the time it was
Key takeaway: Sections 204 or 205 cannot be used to alter the outcome of a valid stockholder vote.
Ten: The Frederick Hsu Living Trust v. ODN Holding Corporation, 2017 WL 1437308 (Del. Ch. Apr. 14, 2017, corrected Apr. 25, 2017) (Laster, Vice Chancellor)
Private equity has many benefits, but it comes with strings. Among the preferred rights a private investor might want in return for its investment is the right to force the company to repurchase its stock, a so-called redemption right. Redemption rights usually have time constraints, which can create divergent interests between the preferred and the typical common stockholders. For instance, the common might prefer a growth strategy in certain years, while holding onto cash or selling off assets might prove more advantageous to the preferred in ensuring a sufficient surplus exists for redemption.
Such a predicament could put directors appointed by the preferred in a pickle, as well as those fiduciaries serving alongside them. While the “preferred” directors’ loyalties might run to the preferred, their fiduciary duties run to the entity and the stockholders as a whole. As a consequence, it would be a breach of fiduciary duties for a board, for instance, to abandon a growth strategy and sell off over 90% of the company’s income-generating assets just so it could amass enough cash to ensure that it can effect the preferred’s redemption right. That is what this decision holds. What makes this decision most worth reading is the Court of Chancery’s robust analysis of the interplay between the board’s contractual duties to the preferred and its fiduciary duties to maximize value for the benefit of the residual claimants. Here, the Court rejected the argument that the company’s contractual duties superseded the board’s fiduciary duties, reasoning, inter alia, that fiduciary discretion remains because, even with an iron-clad contractual obligation, the directors have the option of committing an efficient breach.
Key takeaway: As this decision holds, when it comes to a company’s contractual obligations with a preferred investor, the board remains obligated to act in the best interests of the company and its stockholders as a whole in determining how, or even whether, to comply with the contract.Share