Delaware's Top 10: The Most Important Corporate Law Decisions of 2008
The following is a summary of the top 10 most important corporate law decisions published in 2008. The Delaware courts addressed a range of issues this past year in the areas of fiduciary duty, the negligence - bad faith continuum, advancements and mergers.
The Delaware courts found occasion to reaffirm in one case and expand in two cases the reach of fiduciary duty law.
The Court of Chancery reaffirmed that warrant holders are not owed fiduciary duties and there is no duty to keep them informed. See Corporate Prop. Assoc. 14 Inc. v. CHR Holding Corp., C.A. No. 3231-VCS, 2008 WL 963048 (Del. Ch. Apr. 10, 2008). However, the Court found further that a corporation has a duty to a warrant holder to truthfully answer its inquiries about corporate plans. When asked about a matter that implicated the warrant holders' financial interest, the corporation had a duty to answer truthfully.
The Court of Chancery addressed, for the first time since the enactment of the Delaware Statutory Trust Act, fiduciary duties as they apply in a statutory trust. See Cargill, Inc. v. JWH Special Circumstance LLC, 959 A.2d 1096 (Del. Ch. 2008). The Court found that managers of statutory trusts owe the trust a fiduciary duty absent a clear exclusion of that duty in the trust instrument. The opinion emphasizes two points. First, careful drafting is a primary concern in these alternative entities where trust law will control by default. Second, owners of entities that serve as the managers of statutory trusts may have duties in connection with transactions that arguably benefit the owner. This latter point is consistent with a long line of Delaware case law in other contexts, such as for corporations and limited partnerships.
Finally, a Delaware bankruptcy court held that Caremark duties apply to corporate officers as well as directors, a holding which created a flurry of blog activity and client alerts across the country. See Miller v. McDonald (In re World Health Alternatives, Inc.), 385 B.R. 576 (Bankr. D. Del. 2008). Although fiduciary duties, as applied to officers, are not well defined in Delaware, the Court found that corporate officers have the duty to exercise reasonable care in oversight of corporate operations in their area of responsibility. This holding is hardly a surprise, however, given that the officer involved was considered the company's vice president of operations and general counsel.
The Negligence - Bad Faith Continuum
The Court of Chancery also tackled disputes dealing with the spectrum of conduct ranging from negligence to bad faith.
In Ryan v. Lyondell Chem. Co., C.A. 3176-VCN, 2008 WL 4174038 (Del. Ch. Aug. 29, 2008), the Court of Chancery reaffirmed its previous denial of summary judgment setting off a storm of protest that the Court is ignoring the business judgment rule and the director exculpation statute. The critics argue that when directors are disinterested in a merger, have independent advice and secure a market premium, their decision cannot be reviewed.
This opinion, however, clarifies that the Court knows that even gross negligence is not the same thing as bad faith. Thus, a board that is negligent cannot be held liable for a bad decision when its company has a director exculpation provision in its charter. The opinion carefully reviews the key precedents that discuss the limited circumstances where bad faith will exist, particularly when there is an "intentional dereliction of duty or a conscious disregard of one's responsibilities."
In another notable decision, the Court of Chancery found that for a director of a Delaware corporation to be guilty of gross negligence, his conduct must be so unreasonable that no one could have made the same decision. Venhill Ltd. P’ship v. Hillman, C.A. 1866-VCS, 2008 WL 2270488 (Del. Ch. June 3, 2008). Gross negligence in this context rarely happens and it is thus difficult to find decisions that illustrate the type of conduct that meets this test. Here, the business judgment rule did not apply because the defendant had a conflict of interest.
The Court went to great length to point out that the investment decisions under review exceeded 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.
The Court of Chancery clarified the parameters of advancement rights by affording some directors the right to advancement including all appeals and also warning that directors must be cautious in relying on advancement rights that may be pulled out from under them by later amendment.
In the ongoing saga of Lord Conrad Black, the Court of Chancery decided that -- yes, he is entitled to advancement of his legal fees until his appeals from his criminal conviction are concluded. See Sun-Times Media Group, Inc. v. Black, 954 A.2d 380 (Del. Ch. 2008). The holding turned on an interpretation of a provision allowing advancement until “the final disposition of such action, suit or proceeding” that appears in the Sun-Times bylaws and also in Section 145(e) of the Delaware General Corporation Law. The Court held that the provision included all appeals. Corporations wishing to limit these potentially expensive "blank check" advancement provisions may do so in their bylaws.
Catching many commentators by surprise, the Court of Chancery also warned directors, who rely on advancement rights under a corporate bylaw, to be aware that those rights may be lost if the bylaw is amended. The Court held that a former director’s right to advancement did not vest until an indemnifiable claim was asserted. And, at any time prior to filing an indemnifiable claim against the director, the corporation could amend the bylaws to eliminate the former director’s advancement rights.
The Court of Chancery spent much of its time this year dealing with disputes stemming from merger agreements. These cases addressed the contractual obligation of good faith and remedies for non-compliance with notice provisions of the appraisal statute and for disclosure violations.
There is no shortage of commentary on the Court of Chancery’s decision to uphold the Hexion-Huntsman merger agreement in Hexion Specialty Chem. Inc. v. Huntsman Corp., C.A. 3841-VCL, 2008 WL 4457544 (Del. Ch. Sept. 29, 2008). See previous commentary here. This ninety-one page opinion stirred a flurry of blog activity when the Court found that Hexion had knowingly and intentionally breached the merger agreement. The Court rejected Hexion’s offer to decide whether or not the merged company would be insolvent and, instead, ordered Hexion to comply with its obligation to proceed in good faith to close the deal. In upholding Hexion’s obligation to at least try to obtain the financing to complete the merger, the Court explained that a 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.
The Court of Chancery delved into the murky area of the quasi appraisal remedy in Berger v. Pubco Corp., C.A. 3414-CC, 2008 WL 2224107 (Del. Ch. May 30, 2008). This remedy can be utilized where stockholders may have been prevented from demanding appraisal due to a failure of the corporation to comply fully with the notice provisions of the appraisal statute. In Berger, the corporation used the wrong version of the statute and failed to tell the stockholders of the closely held company how the merger price was set. The Court granted quasi appraisal rights in a form based upon Gilliland v. Motorola, Inc., 873 A.2d 305 (Del. Ch. 2005) which patterned the remedy after the appraisal statute itself. The Court rejected Nebel v. Southwest Bancorp, Inc., C.A. No. 13618, 1995 WL 405750 (Del. Ch. July 5, 1995) as that decision did not squarely address the “contours” of the quasi appraisal remedy. Essentially, the Court required that the corporation start over by sending a corrected notice with the right statute attached and giving stockholders another chance to seek appraisal. This was a more favorable remedy to the company than simply holding that the case may proceed as a class action for all minority stockholders.
Finally, the Court of Chancery attempted to settle the largely unsettled Delaware law as to when damages may be awarded for failing to make proper disclosures to stockholders in a proxy statement. The Court held that it “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.” In re Transkaryotic Therapies, Inc., 954 A.2d 346, 362 (Del. Ch. 2008). On this point, the Court of Chancery received much criticism. One commentator concluded that, to the extent this decision becomes controlling precedent, “it is tantamount to a holding that companies can issue false disclosure that affects the vote of shareholders and escape any consequence so long as the false disclosure remains undisclosed until after the merger closes.” Commentary by J. Robert Brown.
In defense of Transkaryotic, the Court reacted largely to the shareholders’ decision to wait nearly two years after completion of the merger to file the disclosure claims and the simple fact that requiring supplemental, corrective disclosures now would be an exercise in futility. While the net effect is that the appropriate remedy for negligent disclosure violations is an injunction, one would be hard pressed to conclude that under different factual circumstances, where shareholders brought suit shortly after the consummation of the merger, the Court would not reach a different result and grant some form of relief. Additionally, as the opinion makes clear, damages may still be available in circumstances where there is a conflict of interest by the directors or they acted in bad faith.