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Court Upholds Facial Validity of Board-Approved Bylaws

Authored by Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | July 10, 2013

Roscoe Pound once wrote that "law must be stable and yet it cannot stand still." The Delaware Supreme Court in Unocal v. Mesa Petroleum, 493 A.2d 946, 957 (Del. 1985), likewise noted that "our corporate law is not static." Circumstances change and the law cannot be so inflexible as to require the law to stand still. Recently, the burden and expense of stockholder litigation in multiple forums, particularly in merger cases, has increased, creating the additional risk that a court other than the appellate court in the state of incorporation will resolve novel and fundamental questions affecting the internal affairs of a corporation. It is to address this threat that the directors of Chevron and FedEx (and 250 other public corporations) used the power conferred in their certificates of incorporation to adopt bylaws that made Delaware the exclusive forum to bring suit for matters involving the internal affairs of the corporation. In Boilermakers Local 154 Retirement Fund v. Chevron, Civil Action No. 7220-CS (Del. Ch., June 25, 2013), Chancellor Leo E. Strine Jr. echoed Pound and followed Unocal to find that the mere fact that Section 109(b) of the Delaware General Corporation Law had not previously been used to create binding forum-selection clauses for specified shareholder litigation did not preclude boards of a Delaware corporation from so acting today. In so holding, the court provides a useful primer on the standard applicable to facial challenges to bylaws, and a clear rationale for why a board-adopted forum-selection clause is valid statutorily and why it creates a contractual obligation binding on the stockholders even though they did not approve it.

Stockholders Bear Burden of Establishing Invalidity
Delaware law presumes the validity of bylaws. A plaintiff challenging the facial statutory and contractual validity of a bylaw bears the burden of showing "that the bylaws cannot operate lawfully or equitably under any circumstances." To prevail, a plaintiff must show that the bylaw does not address a subject matter within the scope of Section 109(b) and can never operate consistently with law. The court emphasized that whether a bylaw that serves a legitimate purpose may also be used inequitably is irrelevant to its determination of facial statutory and contractual validity. Such a challenge can occur when there is a real-world, extant controversy over the enforcement of a forum selection clause. "By long-standing, settled law, such as-applied challenges are to be raised later, when real-world circumstances give rise to a genuine, concrete dispute requiring judicial resolution," the opinion said. More ›

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Good-Faith and Fair-Dealing Claims Get a New Life

 Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | June 26, 2013

The Delaware Supreme Court on June 10 brought back to life claims alleging liability for a general partner's failure to act in good faith and to deal fairly with limited partners. Until the court's decision in Gerber v. Enterprise Products Holdings, 2013 LEXIS ____ (June 10, 2013), the Court of Chancery permitted general partners to almost escape liability to the limited partners by adopting sweeping exculpation language in limited partnership agreements. Gerberhas now limited the protection such language was thought to provide.

The background to Gerber helps explain its potential significance. The Delaware Revised Uniform Limited Partnership Act (and the Delaware Limited Liability Company Act as well) permits the partners or members to set the terms of their relationship in their partnership agreement. Freedom of contract is king. The DRULPA even permits the partner by their agreement to eliminate the traditional fiduciary duty partners owe to one another. But, there is one exception to that freedom of contract. More ›

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Has the Merger Defense to Derivative Litigation Ended?

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | June 12, 2013

Directors of a Delaware corporation have one sure defense to a derivative suit — eliminate the pesky stockholder plaintiff's standing to sue. Of course, that tactic involves also eliminating all of the other stockholders as well by a cash-out merger and that requires a willing merger partner who is willing to pay fair value for all of the stock. But when there is a controlling stockholder involved and the cash is available, the cash-out merger ends what may be costly litigation.

That is no small benefit. For when the derivative litigation challenges a transaction that allegedly benefited a controlling stockholder, that stockholder and his or her affiliated directors bear the burden of proving what they did was "intrinsically fair" to the corporation. While few such cases go to trial, the few that do have occasionally resulted in very big verdicts. The $1 billion threshold for such a verdict has now been crossed, for example. The costs to defend such claims are also worth considering, particularly for closely-held corporations that may find those costs to outweigh the expense of a cash-out merger. More ›

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The Debate on How to Remedy the Problem of Fast-Filing Plaintiffs in Derivative Actions Continues

Authored by Jason C. Jowers
This article was originally published in Business Law Today | May 2013 

Over the past several years, both the Delaware Supreme Court and the Court of Chancery have recognized the problem of plaintiffs that rush to file derivative actions without first investigating their claims, usually in multiple forums, following the announcement of some corporate trauma. Typically, there is a race to the courthouse by plaintiffs' firms in an effort to obtain lead plaintiff status. Although both courts acknowledge the problem, a satisfactory solution has thus far proven elusive. On April 4, 2013, in Pyott v. Louisiana Mun. Police Employees' Retirement System, __ A.3d __, 2013 WL 1364695 (Del. 2013) ("Allergan"), the Delaware Supreme Court reversed a controversial decision last year by the Delaware Court of Chancery that attempted to address the problem of the fast-filing plaintiff. The lower court had denied dismissal on collateral estoppel grounds of a shareholder derivative action alleging Caremark claims despite the fact that substantially similar claims brought by other shareholders in an action in California had been dismissed with prejudice. Supporting its decision, the Court of Chancery determined that Delaware's demand futility law, which the court believed should be incorporated into the privity prong of California's collateral estoppel test, could not be met because a shareholder does not become the representative of the corporation until a motion to dismiss for failure to make a demand on the board is denied. Additionally, the Court of Chancery found that the shareholder plaintiffs in the California action were not adequate representatives of the corporation because they failed to investigate their claims before bringing the action. In so finding, the trial court established a presumption that fast-filing plaintiffs who do not seek to inspect a corporation's books and records before bringing Caremark derivative claims do not adequately represent the interests of the corporation, but rather represent the interests of the plaintiffs' firms who routinely bring such claims immediately after the announcement of a corporate trauma. More ›

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Expedition Doesn't Extend to Non-Colorable Claims

 Authored by Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | June 5, 2013 

The Delaware Court of Chancery has long expressed its preference that the time to bring a disclosure claim regarding a proposed merger is before the stockholders vote and the deal closes. Such prompt pleading enables the court to fix any potential harm before the merger occurs. In part for that reason, the court follows the practice of "'erring on the side of more [expedited hearings] rather than fewer,'" as it wrote in Ehlen v. Conceptus, C. A. No. 8560, slip op. at 3 (Del. Ch. May 24, 2013). While the standard to obtain expedition is minimal — the plaintiff must demonstrate a colorable claim and a sufficient possibility of irreparable harm — a plaintiff fails to meet it with rote pleading or conduct inconsistent with a demand for expedition. As Ehlen illustrates, the court will require a greater showing of colorability if a plaintiff unduly delays in seeking expedition, even if the delay itself does not constitute laches, and deny as colorable disclosure claims if the plaintiff cannot demonstrate that allegedly omitted information would alter the total mix of information available to the stockholders. More ›

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Is the Court of Chancery Reforming Merger Litigation?

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | May 15, 2013

There is an uproar going on about the practice of filing suit over every merger announced for a publicly traded company. At least 90 percent of merger announcements are followed in a day or two by the filing of complaints alleging the merger is unfair to one or both of the companies involved. Given that these suits are filed so quickly and in almost every deal, they cannot be well researched and may well be meritless. That impression is further confirmed when virtually every one of these suits is soon settled, often for meager, additional disclosures to stockholders and attorney fees for the plaintiffs' lawyers. The whole practice looks too much like legalized extortion. As more than one court has noted, corporate defendants find it cheaper to settle than to litigate these cases.

The problem is compounded when several suits are filed in multiple jurisdictions. That drives up the cost of defense when multiple law firms are retained to cover all the jurisdictions involved. Jurisdictional disputes also occur, again increasing defense costs. Critics have written no end of articles decrying this mess. More ›

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Should Directors Sue Their Company for Its Misdeeds?

 Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | May 8, 2013

What should directors do when their company ignores their efforts to end corporate mismanagement? Until recently, this question rarely came up. Rogue companies are rare in the sense of openly refusing to comply with the law. Directors almost always were able to obtain corrective action when violations of the law came to light. But what if those directors were not able to cure serious management problems? What should they do? More ›

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When Is Advice of Counsel a Defense You Can Raise, but Not Disclose?

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | April 24, 2013

 Most defendants in corporate fiduciary duty litigation want to say, "My lawyer said it was all right." They usually avoid making that point for fear of waiving the attorney-client privilege. A recent Court of Chancery decision suggests that it is possible to say your lawyer advised you without opening the door to disclosure of exactly what the lawyer said. Doing so involves walking a tightrope. One slip and you're waiving your privilege. Yet, the benefits may be worth the risk. More ›

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Does Allergan Spell Litigation Relief?

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | April 17, 2013

The corporate defense bar is excited over the Delaware Supreme Court's April 14 decision in Pyott v. Louisiana Municipal Police Employees' Retirement System, No. 380, 2012 (more often referred to as the "Allergan case"). The Supreme Court reversed a Court of Chancery decision that had refused to dismiss a Delaware derivative complaint notwithstanding that a California federal court had previously dismissed virtually the same complaint. The Court of Chancery ruled that it was not bound under principles of collateral estoppel to follow the federal court ruling. It further held that even if it would normally follow the prior court's decision, it would not in the Allergan case because the California plaintiff had not adequately represented the Allergan stockholders before the California federal court.

The Court of Chancery's Allergan decision had been widely criticized by counsel for corporate defendants. They pointed to the abuse presented when multiple complaints are filed in multiple jurisdictions over a single transaction. That forces defendants to wage a multistate defense. Thus, if the Allergan case decision in the Court of Chancery had been upheld, defendants feared that even if they won one battle, the war against them would continue on another front. The defendants' concern led to several amicus briefs filed in the Delaware Supreme Court urging reversal of the Court of Chancery's Allergan decision. More ›

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Delaware Expands Stockholders' Right to Sue

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | March 27, 2013

On March 15, the Delaware Court of Chancery significantly expanded the right of a stockholder to make direct claims against corporate fiduciaries. Previously, many of those claims were classified as derivative claims that could only be brought in the name of the corporate entity. As a result, stricter pleading rules applied and such claims might be dismissed for a variety of other reasons, such as a cash-out merger that denied standing to the plaintiff or a decision by an independent committee to drop the claim on behalf of the entity. Thus, by expanding the number of "direct" compared to "derivative" claims, the decision in Carsanaro v. Bloodhound Technologies, C.A. 7301-VCL (Mar. 15, 2013), expands stockholder rights. More ›

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Do Directors of Foreign-Based Companies Have Greater Liability Exposure?

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | March 20, 2013

There is a minor uproar over the recent Delaware decision that some suggest holds the directors of a Delaware corporation to a higher standard of corporate governance when the corporation's business is in a foreign country. In a bench ruling declining to dismiss a derivative suit, the court said in In re Puda Coal Stockholders Litigation, Del. Ch. C.A. 6476-CS (February 6, 2013):

"If you're going to have a company domiciled for purpose of its relations with investors in Delaware and the assets and operations of the company are situated in China that, in order for you to meet your obligation of good faith, you better have your physical body in China an awful lot. You better have in place a system of controls to make sure that you know that you actually own the assets. You better have the language skills to navigate the environment in which the company is operating. You better have retained accountants and lawyers who are fit to the task of maintaining a system of controls over a public company." More ›

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What to Expect From Your Delaware Counsel

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | March 6, 2013

Recently, the Delaware Court of Chancery has set out what it expects from Delaware lawyers serving as co-counsel in litigation controlled by non-Delaware attorneys. The court explained: "The concept of 'local counsel' whose role is limited to administrative or ministerial matters has no place in the Court of Chancery. The Delaware lawyers who appear in a case are responsible to the court for the case and its presentation." This raises the related issues of what non-Delaware law firms should expect from their Delaware co-counsel in Delaware litigation and what the Delaware counsel should in turn expect from their non-Delaware co-counsel. Treating these issues openly can only help those relationships More ›

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Contract Precludes Litigation -- Almost

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | January 30, 2013

Delaware law has long permitted parties to a contract to limit remedies for a breach of that contract. But many attorneys believed that no matter what the contract said, a remedy for acting in bad faith still survived and permitted a suit to enforce that remedy. That is still true, but only barely. For, as a recent Court of Chancery decision shows, even a claim for acting in bad faith may be severely limited.

This legal result began by at least by 2002. In that year, the Delaware Supreme Court suggested in Gotham Partners v. Hallwood Realty Partners, 817 A. 2d 160 (Del. 2002), that perhaps the parties to a limited partnership might be able to contract away "traditional notions of fiduciary duties." The Delaware General Assembly readily agreed, by amending the Delaware Limited Partnership Act to expressly permit waivers of any fiduciary duties owed by a general partner to the limited partner investors. Only the duty to act in good faith could not be waived under the Limited Partnership Act or the Limited Liability Company Act. More ›

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What's Behind the Chancery Court's New Rule 5.1

Authored by Peter B. Ladig
This article was originally published in the Delaware Business Court Insider | January 23, 2013

On January 1, Court of Chancery Rule 5.1 became effective, replacing the now-deleted Rule 5(g). The adoption of Rule 5.1 represents a fundamental change to most aspects of the handling of confidential filings in the Court of Chancery. As with any rule, the drafters attempted to craft the rule to account for almost all situations, cognizant of the fact that application of the rule likely would reveal unintended consequences that would need to be addressed in the future. Until the court has sufficient information to determine whether any amendments are necessary, an understanding of the purpose behind certain of the changes in the handling of confidential filings may help bridge any unintended gaps. While the factors listed below are by no means exhaustive, the key tenets behind Rule 5.1 should provide some guidance in uncertain situations. More ›

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Delaware Supreme Court Radically Changes Discovery Scheduling Practice

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | January 9, 2013

In four decisions issued on the same day, January 2, the Delaware Supreme Court has radically changed the common practice among Delaware lawyers concerning discovery schedules in Delaware litigation. Not only do these opinions change how lawyers will handle discovery in Delaware cases, but they also potentially will affect how Delaware's trial courts control their dockets. Much more formal, active case management will be the result. There are severe consequences for those lawyers who do not follow these new procedures. More ›

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