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Supreme Court Affirms Chancery's Ruling That Managing Member Violated Fiduciary Duties

Authored by Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | November 21, 2012

In transactions where a majority of directors or a controlling stockholder stands on both sides, the Delaware courts apply the entire fairness standard of review. That standard also applies in the limited liability company or limited partnership context where the parties adopt that standard by contract. While the two prongs of this nonbifurcated standard are well known — fair dealing and fair price — not that many cases have been tried and resulted in a Court of Chancery opinion that is then subject to review by the Delaware Supreme Court.

Gatz Properties v. Auriga Capital, No. 148, 2012 (Del. Supr. Nov. 7, 2012), is the most recent post-trial entire fairness decision by the Delaware Supreme Court. The court's affirmance that the contract at issue adopted the entire fairness standard for affiliated transactions, that fiduciary duties had been breached, that the limited liability company agreement provided no exculpation and that the lower court properly determined damages provides important guidance to practitioners for transactions subject to entire fairness review. More ›

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Delaware Supreme Court Settles Attorney Sanction Rules

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | November 7, 2012

The Delaware Supreme Court on October 22 decided when and how Delaware lawyers may be sanctioned for the way they conduct litigation. For the first time, that court firmly held that the so-called "objective test" applies in Delaware to determine if a lawyer's conduct is sanctionable under Rule 11. Second, the court held that an attorney is entitled to a hearing where he is able to defend himself before a sanction is imposed. Because the lawyer conduct involved did not violate the objective test, the trial court's sanction was vacated. The decision in Crumplar v. Delaware Superior Court has important implications for the practice of law in Delaware's courts. More ›

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Reports of Industrywide Investigation and Prior Settled Lawsuits Don't Make a Claim Real

Authored by Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | October 24, 2012

In light of the dismissal risk to plaintiffs who do not use the tools at hand to inspect books and records prior to bringing a claim for management failure to oversee a corporation's business and affairs, guidance regarding the standard necessary to support a demand for inspection is important. The recent decision of Louisiana Municipal Police Employees' Retirement System v. Lennar, 2012 WL 4760881 (Del. Ch. Oct. 5, 2012), indicates that newspaper articles reflecting an industrywide government investigation of compliance with the Fair Labor Standards Act and prior lawsuits alleging violations of the FLSA will not suffice.

The plaintiff's demand for books and records pursuant to Section 220 of the Delaware General Corporation Law followed publication in The Wall Street Journal of articles describing an investigation by the U.S. Department of Labor, the IRS and state regulators into compliance by large homebuilders with the FLSA and state law. The defendant's 2011 10-K acknowledged that failure by its employees or subcontractors to comply with state or federal labor law could cause financial and reputational harm to the company. The plaintiff demanded documents, including board minutes, relating to the company and its subcontractors' compliance with federal and state labor, tax and immigration laws. The defendant declined to provide any documents on the ground that the evidence relied upon by the plaintiff — solely the newspaper articles — did not reflect "a credible basis for thinking there has been wrongdoing." The plaintiff sued, claiming that the newspaper articles and the prior lawsuits provided sufficient credible evidence of wrongdoing. More ›

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The Court of Chancery Speaks by Transcript

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | September 12, 2012

Once again, the Internet is changing how Delaware law is made. Those who are not aware of this change will be at a significant disadvantage in litigation in the Court of Chancery. But before describing this change, some background is in order.

In the "good old days" of the 1970s, some important Delaware corporate law was contained in unreported decisions of the Court of Chancery. The court sometimes would decide a major corporate law issue but not submit its decision to the official reporters for publication in the Atlantic Reporter. Usually, this happened when the author of the opinion was pressed for time and did not feel the decision represented his or her best written work. Nonetheless, some of these unpublished opinions went on to become established precedents, at least in Delaware. More ›

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Court of Chancery Explains Why Not All Sale Processes Require Entire Fairness or Revlon Review

Authored by Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | September 5, 2012

Since Kahn v. Lynch in 1994, the Delaware Supreme Court has subjected cash-out merger transactions proposed by controlling stockholders to a higher level of entire fairness scrutiny than the more deferential business judgment review, regardless of whether disinterested directors negotiated the transaction or a majority of the disinterested minority stockholders approved the transaction. Even in a third-party transaction where a controlling stockholder is not on both sides, courts have applied the test of entire fairness where stockholders can allege that a controlling party used its power to cause the company to enter into a transaction that diverted proceeds unfairly to the controlling stockholder at the expense and to the detriment of the minority stockholders. Likewise, since the landmark Revlon decision in 1986, the Delaware Supreme Court in sale-of-control transactions has required defendant directors to prove they followed a reasonable decision-making process and acted reasonably in light of the available information. Because in any of these circumstances the standard of review is less deferential, a minority stockholder attacking a transaction materially increases the prospects of surviving a motion to dismiss if able to plead facts that demonstrate that either entire fairness or intermediate Revlon-level scrutiny applies. In In re Synthes Shareholders Litigation, C.A. No. 6452, 2012 WL 3641014 (Aug. 17, 2012), the Court of Chancery dismissed a complaint attacking a sale transaction in an opinion that demonstrates that mere conclusory allegations that a controlling stockholder favored a sale transaction will not suffice to trigger a higher level of judicial scrutiny where the plaintiff cannot allege a genuine conflict of interest. More ›

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Is Delaware Poised to Dismiss Premature Litigation?

It is striking that a vast majority of deals involving a controlling stockholder lead to litigation filed within days, if not hours, of the public announcement of the transaction. In fact, sometimes litigation is filed even before an actual transaction is announced, simply upon notice that a transaction may be proposed soon. It strains credulity to believe that today so many deals involving controlling stockholders are actionable for breach of fiduciary duty or failure to properly disclose the background to the deal.

Of course, the reality is that these early filings seldom involve a meaningful analysis of the merits. Instead, these early filings represent a race to the courthouse by plaintiffs law firms. The race begins when a law firm first posts on its website or on a company blog set up by day traders that the firm is "investigating" a proposed deal with a controlling stockholder. Soon, the firm and other plaintiffs firms find stockholders who are willing to be their plaintiffs, and the suits follow immediately. Once the company's public filings are made, the various complaints may be amended to attack the filings as inadequate or misleading. Too often, negotiations with the plaintiffs' lawyers immediately follow. A settlement is reached with some modest benefit conferred on the stockholder class and with attorney fees included. This form of "pay-off" is cheaper than litigating all the suits and gains a class-wide release of stockholder claims that adds certainty to the final deal terms. More ›

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Court of Chancery Enforces Contractual Fee-Shifting Provision

Authored by Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | August 8, 2012

 A contract provision in a limited liability company agreement that entitles the prevailing party to reimbursement for all reasonable fees and costs in connection with enforcement of the agreement, including reasonable attorney fees, is not unusual. In defending against such a claim, a nonprevailing party may challenge whether the claims arose under the agreement, whether expenses incurred in related litigation in other courts merit reimbursement and whether the fees are reasonable in light of the comparable fees and rates of the nonprevailing party. Sometimes a question arises, where similar issues exist involving substantially similar contracts but different parties, of whether the court must allocate the fees among the separate parties. What is unusual is for all of these issues to be addressed in one opinion. The Court of Chancery's recent decision in ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member, 2012 WL 3027351 (Del. Ch. July 9, 2012), does just that and provides important guidance to practitioners regarding the nature of a claim for breach of the implied covenant of good faith and fair dealing and enforcement of contractual fee-shifting provisions. More ›

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When May Directors Vote Themselves Bonuses?

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | July 18, 2012

Executive compensation is a hot topic. Congress entered the fray with the Dodd-Frank Act's "say-on-pay" requirements and with Section 162 of the Internal Revenue Code's limits on deductions for some executive compensation payments.

Yet, neither of those measures actually limits what companies may pay their top executives. To do so, stockholders have filed suits arguing it is a breach of fiduciary duty to not follow stockholder votes on say-on-pay resolutions or to not meet Section 162's requirements to obtain a deduction for executive pay.

Those suits have been notably unsuccessful. Indeed, these so-called "Section 162 claims" rarely get beyond the pleading stage, where they are regularly dismissed. The business judgment rule usually insulates from attack the directors' decisions on executive compensation. For example, the Delaware Supreme Court's 2005 opinion in In re The Walt Disney Co. Derivative Litigation, 906 A2d 27 (Del. Sup. 2006), upheld a board decision to pay a $130 million severance package to a single individual. Just a few weeks ago, the Court of Chancery dismissed a similar claim alleging excess compensation in Zucker v. Andreessen, C.A. 6014-VCP (June 21, 2012). More ›

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Delaware's Anonymity? A Response to The New York Times

 Authored by Peter B. Ladig
This article was originally published in the Delaware Business Court Insider | July 11, 2012

Recently, The New York Times published an article alleging that Delaware is, among other things, a potential haven for forming entities involved in criminal activities ("How Delaware Thrives as a Corporate Tax Haven," June 30, http://nyti.ms/M9fhFy). The article also criticized Delaware’s role in tax avoidance, but responding to that argument is beyond my knowledge. The article implied that Delaware is attractive to criminal activities because the state has virtually no means of determining who incorporates entities in Delaware.

In support of this contention, the article quotes a registration agent stating that Delaware requires the least amount of information in order to form a corporation under its laws. While a detailed response to this type of criticism would be beyond the scope of this article, the record should be set straight on what Delaware does require, and how the disclosure required by Delaware differs from the disclosure requirements in other states, because the article itself never discusses that. More ›

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Delaware Court of Chancery Sets New Rules for Derivative Claims

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | June 20, 2012

The Delaware Court of Chancery just issued possibly the most important decision in the last 10 years on derivative claims. In Louisiana Municipal Police Employees' Retirement System v. Pyott, Del. Ch. Ct. 5795-VCL (June 11, 2012), the court clarified when a previously dismissed derivative suit may be refiled and what plaintiffs should do to properly satisfy the requirement that individual stockholder plaintiffs adequately allege why they, rather than a corporation's board of directors, should control derivative claims brought on behalf of the corporation. Because derivative litigation is a principal tool to ensure proper corporate governance, this decision has large implications. More ›

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State Supreme Court Reaffirms Strict Procedural Requirements for Inspection of Books and Records

Authored by Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | June 13, 2012

Cases brought under Section 220 of the Delaware General Corporation Law reflect the Delaware General Assembly's effort to balance the stockholder's important right to seek inspection of books and records to investigate wrongdoing with the directors' right to manage the business and affairs of the entity without undue interference from stockholders. In 2003, the Delaware General Assembly extended the right to demand inspection from stockholders of record to beneficial stockholders, but only if the beneficial holder states under oath with the demand that he or she is a beneficial holder, provides documentary evidence of beneficial ownership of the stock and states that such evidence is a true and correct copy of what it purports to be. More ›

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Confirming a Settlement That Your Client Hates

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | May 16, 2012

Representing clients in class or derivative litigation is often tricky when a settlement is on the table. Your duty is to protect the class members or the entities that are your true clients.

But what happens when the class representative or nominal plaintiff does not agree with you? The usual solution to this dilemma, at least when considering a proposed settlement, is to take the dispute to the court for it to resolve. After all, the court will require that the class or other stockholders receive notice of the proposed settlement and will hear and decide any objection to it. What could be simpler? More ›

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Delaware's Business Courts Seek Comments

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | May 2, 2012

In May 2010, the Delaware Supreme Court established its Complex Commercial Litigation Division. The CCLD is a true "business court," intended to supplement and complement Delaware's pre-eminent court for business disputes, the Delaware Court of Chancery. Since it was established, more than 100 civil actions have been filed in the CCLD. More ›

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Failure to Plead Demand Futility Risks Losing Attorney Fees

Authored by Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | April 11, 2012

When a defendant engages in arguably unlawful conduct, a plaintiff files an action to complain about and seek relief prohibiting the unlawful conduct, and the defendant thereafter changes its practices and moots the plaintiff's complaint, a plaintiff may be entitled to attorney fees based upon the benefit conferred. Absent such a rule, a plaintiffs counsel could undertake a contingent-fee case, incur fees to investigate and file the action and then wind up with no case and no compensation, even though the defendant had changed its practices in a manner consistent with the plaintiff's demand. More ›

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What to Do When the Injunction Is Denied but the Directors Made a Mistake

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | April 4, 2012

Recently, the Delaware Court of Chancery has found wrongful conduct but denied the remedy plaintiffs sought. The El Paso case is a prime example.

The court found the board of directors and, particularly, El Paso's president had failed to act properly in negotiating a merger. Even the company's investment bankers had a conflict of interests, yet, despite critical language in its opinion, the court refused to enjoin the merger. More ›

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