Delaware Corporate and Commercial Case Law Year In Review – 2016
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 – 2016. 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 disclosure-only settlements, appraisal rights, books and records inspections, and the standards of review in shareholder litigation. Continue reading for the full article.
Delaware Corporate and Commercial Case Law Year In Review – 2016
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: In re Trulia, Inc. Stockholders Litigation, 129 A.3d 884 (Del. Ch. 2016)
Deal litigation has proliferated in recent years, as have court-approved “disclosure-only” settlements with broad releases for defendants and sizable fee awards for plaintiffs’ counsel. Criticism abounded. In several well-publicized ruling in the second half of 2015, the Court of Chancery signaled a shift towards increasing scrutiny of disclosure-only settlements. Trulia was the culmination of this trend and is significant in two respects.
First, Trulia announced the Court of Chancery’s “optimal” approach for adjudicating disclosure claims—either (1) on a preliminary injunction motion, or (2) on a mootness fee application, after the defendants publicize claim-mooting supplemental disclosures. Both means preserve the adversarial process and avoid the Court being asked to approve a disclosure-only settlement without the benefit of an opposing view, after little or no motion practice, and on a minimal discovery record.
Second, Trulia set a new, more demanding test for the Court’s approval of disclosure-only settlements. For parties choosing the “suboptimal” disclosure-only settlement path, the Court warned that the settlements will be “met with continued disfavor in the future unless the supplemental disclosures address a plainly material misrepresentation or omission, and the subject matter of the proposed release is narrowly circumscribed to encompass nothing more than disclosure claims and fiduciary duty claims concerning the sale process, if the record shows that such claims have been investigated sufficiently.” The phrase “plainly material” meant that it “should not be a close call that the supplemental information is material as that term is defined under Delaware law.”
Key takeaway: After Trulia, parties seeking approval of a disclosure-only settlement in Delaware should expect increased scrutiny over the supplemental disclosures’ materiality, plaintiffs’ investigation of potential non-disclosure claims, and the scope of the release to defendants relative to the value of the released claims. Although long-term effects remain to be seen, Trulia likely will reduce so-called deal tax litigation in Delaware.
Two: Singh v. Attenborough, 137 A.3d 151 (Del. 2016) (ORDER);
In re Volcano Corp. Stockholder Litigation, 143 A.3d 727
(Del. Ch. 2016); Larkin v. Shah, 2016 WL 4485447
(Del. Ch. Aug. 25, 2016)
Singh v. Attenborough
In Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), the Delaware Supreme Court reaffirmed that stockholder approval may invoke the deferential business judgment rule, even where the stockholder vote is required by statute. Under Corwin, where a transaction “not subject to the entire fairness standard of review has been approved by a fully-informed, uncoerced majority of the disinterested stockholders,” Delaware courts will apply the business judgment rule. Singh clarified Corwin’s application.
Singh affirmed the dismissal of post-closing fiduciary duty claims under Corwin which were the subject of two trial court decisions (In re Zale Corp. Stockholders Litig., 2015 WL 5853693 (Del. Ch. Oct. 1, 2015) (“Zale I”), opinion amended on reargument, 2015 WL 6551418 (Del. Ch. Oct. 29, 2015) (“Zale II”)). Zale I was decided just before Corwin, and applied the intermediate level enhanced scrutiny standard of review under Revlon (despite stockholder approval of the merger) and upheld a claim that a banker aided and abetted a duty of care breach by the board. Zale II revisited Zale I just after Corwin. On reargument, the Court of Chancery held that the stockholder vote invoked the business judgment standard of review under Corwin, replacing the otherwise applicable Revlon review. But, the Court still asked whether the plaintiffs rebutted the business judgment rule by adequately pleading director gross negligence (the standard for pleading a duty of care breach), something plaintiffs failed to do.
The Delaware Supreme Court upheld the dismissal on appeal in Singh, but disagreed with the Zale II decision in a significant respect. The Supreme Court explained that while the Court of Chancery correctly found that the stockholder vote invoked business judgment review under Corwin, it improperly asked whether the plaintiffs rebutted the business judgment rule by pleading a duty of care claim under the gross negligence standard. Because a Corwin-qualifying vote invoked the business judgment rule, the only question was whether plaintiffs adequately pled waste. And, according to the Supreme Court, dismissal is the likely result under these circumstances because waste is vestigial, having “long had little real-world relevance because it has been understood that stockholders would be unlikely to approve a transaction that is wasteful.”
Key takeaway: After Singh, once a vote is found to satisfy Corwin and invoke the business judgment rule, the Court of Chancery will not ask whether the plaintiff rebutted the business judgment rule by sufficiently alleging director gross negligence. The two decisions discussed next further examined the effect of a Corwin-qualifying vote following Singh.
Volcano & Larkin
First, Volcano and Larkin are notable for extending Corwin beyond long-form mergers to two-step medium-form mergers, where instead of voting, a target’s stockholders express approval by tendering their shares in a first-step tender offer. As a matter of first impression, the Court of Chancery in Volcano determined that Corwin may apply after a successful first-step tender offer, reasoning that accepting a tender offer in a medium-form merger replicates voting to approve a long-form merger. Thus, a majority of the outstanding, fully-informed, uncoerced, disinterested stockholders’ tender of their shares also invokes the business judgment rule under Corwin. Larkin reached the same conclusion.
Second, Volcano and Larkin also are notable for styling the business judgment rule invoked under Corwin as “irrebuttable.” In short, consistent with Singh, Volcano and Larkin signaled that a Corwin-qualifying vote invokes the business judgment rule irrebuttably, cleansing board-level conflicts and lapses of care, and leaving plaintiffs to allege waste. In reaching this conclusion, Larkin expressly held that the only transactions subject to the heightened entire fairness standard of review that stockholder approval cannot cleanse are those involving a conflicted controlling stockholder, where Delaware law presumes coercive influence and from the outset applies entire fairness review. Thus, absent a conflicted controller, a Corwin-qualifying vote invokes the business judgment rule irrebuttably, leaving only a waste claim.
Key Takeaway: Volcano and Larkin provided important guidance regarding the effect of a Corwin-qualifying vote. Under both decisions, because the business judgment rule applies irrebuttably under Corwin, the only potential deal challenge once Corwin applies is an untenable waste claim.
Three: Amalgamated Bank v. Yahoo!, Inc., 132 A.3d 752 (Del. Ch. 2016)
A books and records demand is the chief tool for stockholders to investigate potential breaches of fiduciary duty by the corporation’s directors or officers and the best opportunity to bolster their complaint and avoid dismissal for failure to state a claim or to plead demand futility. When the stockholder’s inspection purpose is to investigate possible mismanagement, the burden is quite low—the stockholder need only show, by a preponderance of the evidence, a “credible basis” from which the Court of Chancery can infer there is possible mismanagement that warrants further investigation. If the stockholder makes this showing, the scope of books and records it may obtain are those “necessary” and “sufficient” to fulfill its investigative purpose. Most often this means the stockholder may obtain board level documents evidencing the directors’ decisions and deliberations, as well as the materials the directors received and considered. But, as the Yahoo! post-trial decision explains, the inspection may be broader depending on the circumstances.
Yahoo! is significant for two primary reasons: its examination, first, of when officer or employee level documents may be obtained through a books and records demand, and, second, when an inspection may encompass electronically-stored information, including emails sent or received using a director’s or officer’s personal email account. While Yahoo! is not the first decision ordering the production of electronically-stored information, this decision most comprehensively addresses the issue. Yahoo! also is significant for upholding, after trial, an “incorporation condition” that the company requested be placed on the stockholder’s inspection. Under that condition, if the stockholder references any documents obtained through its inspection in a resulting plenary action complaint, then the full universe of the corporation’s books and records production would be deemed incorporated by reference into the complaint, ensuring the stockholder cannot cherry-pick from the books and records in its plenary action to avoid a motion to dismiss.
Key takeaway: Electronically-stored information that is necessary and sufficient to the stockholder’s inspection purpose falls within the books and records statute, and this includes communications on a director’s or officer’s personal email account when used for corporate business. Companies and their personnel should be aware of this potential, as it may affect what preservation steps are appropriate once they learn of possible books and records litigation.
Four: Hazout v. Tsang, 134 A.3d 274 (Del. 2016)
Delaware has a consent-to-service statute for directors and officers of Delaware corporations (10 Del. C. § 3114). Individuals agreeing to serve as a director or officer of a Delaware corporation consent to be sued in a Delaware court in actions “by or on behalf of, or against such corporation, in which such [director or officer] is a necessary or proper party, or in any action or proceeding against such [director or officer] for violation of a duty in such capacity ….”
A 1980 decision of the Court of Chancery had read the current statute to cover only actions in which at least one count of the complaint alleged that the individual defendant had breached a fiduciary duty in his role as a director or officer; that effectively read the “necessary or proper party” language out of the statute.
The Delaware Supreme Court rejected that approach in Hazout and held that the consent statute also covers actions involving the corporation where the director or officer is a “necessary or proper party,” regardless of whether the case includes a claim for breach of fiduciary duty against the director or officer. The Supreme Court defended the constitutionality of its reading by explaining how “the implied consent mechanism of § 3114 only applies when a director or officer faces claims that arise out of his exercise of his corporate powers.”
Key takeaway: Individuals agreeing to serve as directors or officers of a Delaware corporation may be amenable to jurisdiction in Delaware not just for breach of fiduciary duty claims, but also in actions which they are a necessary or proper party because the claims arise out of their exercise of corporate powers.
Five: Sandys v. Pincus, 2016 WL 7094027 (Del. Dec. 5, 2016)
Under Delaware law, a threshold requirement to bringing a derivative action on the corporation’s behalf is a pre-suit demand on the board or a showing of why that demand would be futile. When the plaintiff elects to sue without making a pre-suit demand and defendants move to dismiss under Court of Chancery Rule 23.1, the question becomes whether the plaintiff has pled sufficient particularized facts creating a reasonable doubt that at least half of the board could not have impartially considered a pre-suit demand because the directors are interested or lack independence.
Sandys clarifies the type of allegations that might establish a lack of independence, and arguably relaxes the standard, as the dissent suggests. In this non-unanimous decision, the Delaware Supreme Court disagreed with the Court of Chancery’s finding that a majority of the directors was independent from the controlling stockholder. According to the Supreme Court majority, one director lacked independence based on her personal relationship with the controlling stockholder, evidenced by the fact that they co-owned an aircraft. Two other directors lacked independence based on their professional relationships with the controlling stockholder, evidenced by their venture capital ties and the fact that the company had deemed both directors not independent under stock exchange rules for unspecified reasons.
Key takeaway: Sandys is an important decision clarifying how the Delaware courts will review allegations of a lack of independence in the demand futility context, particularly where the relevant company has a controlling stockholder.
Six: In re Appraisal of Dell, Inc., 2016 WL 3186538
(Del. Ch. May 31, 2016)
Delaware law has 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.
In Dell, the Court of Chancery declined to find that the deal price was the best evidence of fair value, despite a fairly robust arm’s-length sales process conducted by a special committee of the board. The Court’s reasons for not deferring to the deal price included that the transaction was a leveraged management buyout and that the only active bidders were not strategic buyers, but financial buyers who utilized leveraged buyout valuation models. Employing its own DCF analysis, the Court found the actual fair value was nearly 30% over the deal price.
Key takeaway: Dell provides a sharp reminder that the deal price will not always be accepted as the most reliable evidence of fair value in an appraisal proceeding, at least when the transaction is a leveraged management buyout, even where the transaction resulted from a careful sales effort free of any fiduciary duty breach.
Seven: In re Appraisal of DFC Global Corp., 2016 WL 3753123
(Del. Ch. July 8, 2016)
After Dell provided a wrinkle on the issue of market price representing fair value, DFC Global bucked the trend of the market price generally representing fair value in an arm’s-length deal with a robust sales process.
In DFC Global, the Court of Chancery found the deal price in a third-party transaction was not the best evidence of fair value notwithstanding a two-year sale process. According to the Court, the market conditions at the time of the sale were not conducive to achieving fair value for the company. Company turmoil and regulatory uncertainty raised questions about the reliability of the deal price and management’s financial projections. So, rather than deferring to the deal price, the Court calculated fair value by giving equal weight to three admittedly “imperfect” techniques—the Court’s own modification of the competing expert DCF analyses, a comparable companies multiple analysis, and the merger price. That calculation resulted in a fair value about 7% over the deal price.
Key takeaway: Issues affecting a company in a regulated industry, like banking, at the time the company undertakes a sale process might result in the Court giving lesser weight to the deal price in an appraisal action, making it all the more important to submit credible expert testimony regarding a discounted cash flow analysis or other valuation methods.
Eight: In re Books-A-Million Stockholder Litigation, 2016 WL 5874974 (Del. Ch. Oct. 10, 2016)
When there is a challenge to a going-private squeeze-out merger with a controlling stockholder, Delaware law applies its most rigorous standard of review—entire fairness review. But, the most deferential standard of review—business judgment review—will apply instead if the deal is structured to satisfy the framework recently approved by the Delaware Supreme Court in Kahn v. M&F Worldwide, 88 A.3d 635 (Del. 2014) (“MFW”). The MFW framework requires that the controlling stockholder condition the merger on (1) the approval of an independent, adequately empowered special committee, that fulfills its duty of care in negotiating a fair deal price, and (2) the uncoerced, informed vote of a majority of the minority disinterested, independent stockholders. When MFW is satisfied, the business judgment rule applies, and the only potential deal challenge is an untenable waste claim.
Books-A-Million is significant because it finds that a controlling stockholder satisfied the MFW framework. As a result, the stockholder obtained business judgment review of a squeeze-out merger on its successful motion to dismiss. Books-A-Million also is notable for its discussion of how the Court will analyze claims of bad faith in connection with a merger structured to satisfy MFW. In short, bad faith may bring the case outside of MFW, but sufficiently pleading bad faith is a very difficult route.
Key takeaway: Books-A-Million provides important insight into the requirements for a controller to satisfy the MFW framework and avoid entire fairness review. To ensure that a squeeze-out merger challenge may be tested under MFW on a motion to dismiss, practitioners should describe compliance with the MFW requirements in board resolutions and the proxy suitable for judicial notice.
Nine: In re Wal-Mart Stores, Inc. Derivative Litigation, 2016
WL 2908344 (Del. Ch. May 13, 2016)
When derivative actions challenging the same underlying conduct are brought in multiple forums, findings by one court as to one group of stockholders may preclude another group of stockholders from litigating the already decided issues in a different court. That is what happened in Wal-Mart.
A bribing scandal involving Wal-Mart and the Mexican government gave rise to multiple lawsuits, including a derivative action in Arkansas federal court and another in the Delaware Court of Chancery. The Delaware derivative action followed a lengthy books and records action in the Court of Chancery (and an appeal before the Delaware Supreme Court), while the Arkansas litigation advanced. The Arkansas district court eventually dismissed the complaint before it for failure to plead demand futility under Delaware law.
In Wal-Mart, the Court of Chancery held the Arkansas district court’s order precluded the Delaware plaintiffs from relitigating demand futility, resulting in a dismissal. The Delaware plaintiffs tried to avoid dismissal by arguing that the Arkansas plaintiffs were inadequate representatives, citing their failure to obtain books and records before bringing a plenary action. The Court of Chancery rejected this argument, finding that while the Arkansas plaintiffs’ strategy potentially was “ill-advised,” it was not “so grossly deficient as to render them inadequate representatives” for issue preclusion purposes.
Key takeaway: Wal-Mart provides important guidance on issue preclusion in multi-forum derivative litigation, and also underscores the inefficiencies of multi-forum litigation.
Ten: El Paso Pipeline GP Company LLC v. Brinckerhoff, 2016
WL 7380418 (Del. Dec. 20, 2016)
Under Delaware law, a derivative claim is a corporate asset that passes to the surviving entity in a merger. Thus, a merger may extinguish a stockholder’s standing to bring a derivative action. The question of whether a claim is derivative or direct can be difficult, further complicated by case law following the Gentile decision, which holds that certain claims are dual-natured—partially direct, partially derivative. El Paso clarified the standards in this area.
In El Paso, the Court of Chancery held that claims of a limited partner challenging a drop down transaction between the general partner’s parent and the partnership as a breach of the partnership agreement were direct, rather than derivative, and therefore were not extinguished by a merger following the trial. The Court of Chancery awarded $171 million in damages for that breach.
The Delaware Supreme Court reversed, finding that although the claim involved breach of the partnership agreement, the claim was derivative. The heart of the plaintiff’s claim was that the partnership paid too much for the parent’s assets acquired in the drop down. The benefit of any recovery for that claim would flow solely to the partnership, making it a classically derivative claim. The Court distinguished this type of claim from Gentile, where the Court found that a dilutive transaction between the company and its controlling stockholder was derivative and direct, on the ground that the general partner in El Paso did not gain additional voting power or control through the transaction. Thus, the claim was derivative and did not survive the merger (though the plaintiff could challenge the merger’s fairness).
Chief Justice Strine added a concurring opinion which expressed doubt about Gentile’s continued viability. The Chief Justice agreed that because the transaction in this case had no effect on the limited partners’ voting rights, the Supreme Court did not need to consider whether to overrule or modify Gentile. He suggested, however, that Gentile should be overruled to the extent it allows for a direct claim in dilution cases where a stockholder had a controlling interest before the challenged transaction.
Key takeaway: El Paso declined to extend Gentile to cases involving expropriation of economic value where voting rights and control are unaffected. Additionally, the Chief Justice’s concurring opinion gives reason to doubt Gentile’s continued viability.
Morris James LLP ©
This article was published in Transaction Advisors in January 2017.
Transaction Advisors, a prestigious technical journal, publishes white papers, technical articles, and research studies on the critical issues impacting corporate transaction planning, structuring, and execution. For more information, visit www.transactionadvisors.com.
For more information on the article, please contact Albert Manwaring at 302.888.6868 or firstname.lastname@example.org.