Posts tagged Directors

Court of Chancery Approves Option Back Dating Case Settlement

Ryan v. Gifford, C.A. 2213-CC (Del. Ch. Jan. 2, 2009)

 

In this decision the Court approves the settlement of a stock option back dating case. The opinion carefully goes through all the analysis of when to approve a settlement, particularly when the recovery is adequate under the circumstances.

 

The attorney fee award of $9,000,000 or about $1,100 per hour shows that contrary to some beliefs, the Court is prepared to award significant fees for hard, excellent work that achieves a good result.

 

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The Delaware "Bad Faith" Dilemma: The Problem And A Possible Solution

Introduction
A recent Delaware Court of Chancery decision has generated much discussion over whether disinterested directors may be held liable for approving a transaction that appeared reasonable to them and their advisors. Indeed, by holding that the directors may have acted in “bad faith,” the decision seemed to some to be a threat to the core principles embodied in the business judgment rule. That rule protects directors from being second guessed by courts long after the business decision has been made. These concerns are overstated. This article will: (1) outline the background to the current controversy over “bad faith” in Delaware, (2) predict how the Delaware Supreme Court will clarify the Delaware law of “bad faith” and (3) suggest a possible solution to address lingering concerns over director liability for disinterested business decisions.

The “Problem”
For many years Delaware limited director liability for disinterested business decisions to those decisions properly held to be grossly negligent. This high standard seemed adequate to protect directors from inappropriate judicial second guessing. Then in 1985, Smith v. Van Gorkom held a board was grossly negligent. Many commentators felt Van Gorkom demonstrated the inability of courts to understand what should constitute gross negligence. The Delaware Legislature promptly responded to Van Gorkom by adopting Section 102(b)(7) of the Delaware General Corporation law. That new statute permitted Delaware corporations to include a provision in their certificate of incorporation that immunized directors for even grossly negligent decisions. Section 102(b)(7) has its exceptions, however. One of those is that actions “not in good faith” lose the statutory protection from liability.

As might be expected, if directors could not be successfully sued for actions “in good faith,” it was only a matter of time before plaintiffs filed claims alleging directors had acted in “bad faith”.

Bad Faith
Bad faith remained largely undefined until 2005. After much debate regarding whether good faith was an independent fiduciary duty and what exactly constitutes good (and bad) faith, Chancellor Chandler defined bad faith as an “intentional dereliction of duty, a conscious disregard for one’s responsibilities” and a “[d]eliberate indifference and inaction in the face of a duty to act.” The Delaware Supreme Court then set out three different categories of fiduciary behavior that might deserve the “bad faith pejorative label.” The first, fiduciary conduct motivated by an intent to do harm, was aptly labeled “subjective bad faith” The second category involves “fiduciary action taken solely by reason of gross negligence and without any malevolent intent,” a lack of due care. The court decided, however, that gross negligence without more does not constitute bad faith, and thus does not breach the duty of loyalty. The third category is the Chancellor’s definition of bad faith, as intentional dereliction of duty, a conscious disregard for one’s responsibilities. In Stone v. Ritter, the court further stated bad faith is a “fail[ure] to act in the face of a known duty to act, thereby demonstrating a conscious disregard for [one’s] responsibilities,” and thus not exculpated under § 102(b)(7). More ›

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Court of Chancery Upholds Director Decision Rejected by Stockholders

In re Lear Corp. S'holder Litig., C.A. 2778-VCS (Del. Ch. Sept. 2, 2008)

In this decision the court dismissed claims against directors whose decision to approve a merger was rejected by the stockholders and the company then had to pay a termination fee. The Court carefully explains why directors may sometimes be wrong, but without incurring any liability for that decision.

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Court of Chancery Defines Bad Faith, Again

McPadden v. Sidhu, C.A. 3310-CC (Del Ch. Aug. 29, 2008) 

This decision again affirms that bad faith is not the same a gross negligence and explains the difference. That distinction is important because usually directors are immunized from decisions made in good faith, even if negligent.

 

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Court of Chancery Answers its Critics of the Ryan Decision

Ryan v. Lyondell Chemical Company, C.A. 3176-VCN (Del Ch. Aug. 29, 2008)

The recent decision in this case denying summary judgment has set off a storm of protest that the Court of Chancery 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 more recent decision in the same case denying an application to take an appeal effectively answers those critics.

This opinion makes it clear that the Court knows very well 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."

The key to the prior opinion, as the court’s opinion points out many times, is that it was based on a limited summary judgment record that required the court to accept all the allegations of the complaint and draw all reasonable inferences against the directors. Indeed, two even more recent decisions make it clear the Court of Chancery is upholding the business judgment rule and the statutory protection of directors who act in good faith. See McPaddin v. Sidhu, C.A. 3310-CC (Del. Ch. Aug. 29, 2008) and In re Lear Corporation Shareholders Litigation, C.A. 2728-VCS (Del. Ch. Sept. 2, 2008).

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Court of Chancery Denies Advancement for Litigation Instituted by a Director

Donohue v. Conning, C.A. 3733-VCS (Del. Ch. June 20,2008)

The Delaware Supreme Court has upheld a claim for fee advancement in litigation instituted by a former director, even though advancement has usually been thought of as a right to defense fees. This decision shows how limited that right may be when the advancement provision relied upon does not clearly provide for fees when the director starts the fight. For in such a case, the court held that there is no right to have fees advanced.

The decision has some unusual facts and may not cover another case were the director is clearly threatened with ligitaion and wins the race to the couthouse.

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District Court Denies Motion to Dismiss, Allows Duty of Care, Loyalty and Fraud Claims to Proceed

Ad Hoc Comm. of Equity Holders of Tectonic Network, Inc. v. Wolford, 2008 WL 212 7464 (D. Del. May 21, 2008)

The District Court recently allowed claims for breach of the duties of care and loyalty against former directors and officers of Tectonic Network, Inc. (the “Company”) to go forward, rejecting Defendants’ jurisdiction, standing and insufficient claim arguments. Plaintiff, an Ad Hoc Committee of Equity Holders in the Company, sued Defendants for purportedly improper conduct in connection with the acquisition of three businesses and the resulting sale of one of the Company’s subsidiaries. Plaintiff alleged that Defendant Officers (Officer #1 and Officer #2) committed fraud related to the Company’s actions, and all Defendants breached their fiduciary duties. Specifically, Plaintiff alleged that the Defendants breached their fiduciary duties in recommending and/or approving the acquisition of the three businesses, all of which Officer #1 had a majority interest in. Plaintiff also alleged that the Defendant Officers committed fraud in making material misrepresentations to the board regarding the profitability of the acquired businesses and the prospective profitability of a future business plan that resulted in the sale of the Company’s subsidiary. Subsequent to acquisitions and sales, the Company’s financial picture worsened, and it filed for voluntary Chapter 11 bankruptcy. The Bankruptcy Court lifted the stay to allow Plaintiff to press its claims outside of the bankruptcy proceedings. More ›

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District Court Finds That Participation in Delaware Merger Confers Jurisdiction, Denies Motion to Dismiss

G & G LLC v. White, 2008 WL 205150 (D. Del. Jan. 25, 2008)

In this opinion declining to dismiss for lack of personal jurisdiction, the District Court found that it had personal jurisdiction over both the directors/officers of a Delaware corporation and over a foreign corporation that invested in a Delaware corporation. Plaintiff was a Virginia limited liability company that loaned $2.5 million to a Utah corporation. Plaintiff was granted a security interest in the Utah corporation’s assets, and perfected that interest by filing the required financing statements in Utah. However, the Utah corporation subsequently was merged with and into a Delaware corporation. Plaintiff asserted that this was done at the insistence of various defendants that were seeking to invest in the Utah corporation after Plaintiff informed them that it would not agree to subordinate its security interest to theirs. Plaintiff posited that the investor defendants thereafter controlled the Utah corporation and the Delaware corporation it was merged into, and fraudulently concealed the merger to prevent Plaintiff from perfecting its security interest upon the merger, while at the same time perfecting their own in Delaware. Plaintiff pointed to numerous instances where the Utah corporation, the Delaware corporation, their counsel, the directors/officers of the Delaware corporation (who were appointed by the investor defendants), and the investor defendants failed to notify Plaintiff of the merger and/or made misrepresentations regarding the continuing status of the corporation as a Utah corporation. Taking the allegations as true, the Court found that the actions of the investor defendants and the directors they appointed was sufficient to confer specific jurisdiction over them.  More ›

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Court of Chancery Holds Board Meeting Is Void

Fogel v. U.S. Energy Systems, Inc., C.A. No. 3271-CC (December 13, 2007).

Directors often think that if they get together that is a real board of directors'  meeting. Not so. As this decision holds, a board meeting is a formal event that must be preceded by the appropriate notice, be conducted by voting on the issues and otherwise be properly called and conducted. Gatherings of even all the directors that do not meet these tests are void.

Moreover, the consequence of holding a meeting void is that actions taken cannot be ratified later. Thus, even when all but one of the company's directors wanted to fire the CEO, their attempt to do so at a haste gathering of all the directors was ineffective.

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District Court Applies Delaware Statute of Limitations Carve Out For Fiduciary Claims, Denies Summary Judgment

Norman v. Elkin, 2007 WL 2822798 (D.Del. Sept. 26, 2007)

In this action the District Court evaluated the application of the statute of limitations to claims that a corporate fiduciary engaged in self-dealing at the corporation’s expense. Plaintiff was a 25% shareholder in a closely-held Delaware corporation with Pennsylvania headquarters, formed to participate in the wireless communications industry. Defendant #1 owned the remaining shares of the corporation, and also served as its President and sole director. Plaintiff alleged that Defendant #1 breached his duties to the corporation when he personally obtained newly-issued communications licenses from the FCC, then sold them along with the corporation’s pre-existing licenses to a third party, keeping the proceeds of the sale himself. Plaintiff further alleged that Defendant #1 took the action without notifying Plaintiff in his capacity as a shareholder, without holding an annual meeting, and without making any disclosure of the sale. Plaintiff sued Defendant #1, along with his wholly owned corporation and another corporate officer, in the Delaware Court of Chancery for breach of contract, unjust enrichment, declaratory relief, and breach of various fiduciary duties. Defendants removed the action to District Court based on diverse citizenship and moved for summary judgment, arguing that all claims were time-barred. More ›

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Court of Chancery Permits Security For Advancement

Thompson v. The Williams Companies, Inc., C.A. No. 2716-VCS (July 31, 2007).

Companies often find that they are required to provide advancement of attorney fees to former directors or others when the company really does not want to do so because of the conduct involved. Here, in a case involving an employee with an advancement  right, the Court held that requiring security for the amounts advanced is appropriate to insure repayment.

Note, however, that this discretion to require security was based on the terms of the provisions providing for advancement. Without that language in a mandatory advancement provision, it is doubtful that a company might require more than the usual and customary undertaking to repay.

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District Court Declines to Exercise Supplemental Jurisdiction Over Fiduciary Duty Claims, Grants Motion to Dismiss

Lemon Bay Partners LLP v. Hammonds, C.A. No. 05-327 (D.Del. June 26, 2007)

 

In this shareholder derivative action for breach of fiduciary duties against various corporate defendants, the Court held that the state law claims asserted so predominated the lone federal claim that exercise of supplemental jurisdiction was inappropriate. Plaintiffs, former shareholders of MBNA Corporation, asserted various claims against the defendants based on breach of fiduciary duties in connection with earnings reports and the merger of MBNA with Bank of America. Defendants moved to dismiss based on lack of subject matter jurisdiction, arguing that the Plaintiffs’ sole claim that rested on federal jurisdiction was so predominated by the state law claims as to make the exercise of the Court’s supplemental jurisdiction inappropriate. The Court concurred with the defendants, concluding that Plaintiffs’ federal law claim bore only a tangential relationship to the rest of the claims. The Court therefore granted Defendants’ motion to dismiss for lack of subject matter jurisdiction.  More ›

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Court of Chancery Upholds Advance Notice Bylaw

Openwave Systems Inc. v. Harbinger Capital  Partners Master Fund I, Ltd., C.A. No. 2690-VCL (May 18, 2007).

Corporate bylaws sometimes require that the company be given advance notice of the intent to nominate anyone for election to the board. When those provisions are not clear, they will be interpreted in the way that expands stockholder rights. However, when the provisions are clear enough to give notice of their minimum requirements, then they will be enforced. That is what occurred here where the winning candidate was disqualified for his failure to comply with a reasonably clear advanced-notice bylaw.

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District Court Applies SEC Rules Amendments to Transaction, Grants Summary Judgment

Levy v. Sterling Holding Co., LLC, 2007 WL 582555 (D.Del. Feb. 13, 2007).

In this shareholder derivative action, the plaintiff shareholder sued two defendants, both of whom occupied board positions with the corporation, for allegedly purchasing stock in the corporation and then selling it at a profit within six months, in violation of Section 16(b) of the Securities and Exchange Act of 1934. After each side filed cross-motions for summary judgment, the SEC adopted Amendments to SEC Rules 16b-3 and 16b-7, which exempt certain transactions from the prohibitions of Section 16(b). Defendants argued that the transaction that formed the basis of Plaintiff’s complaint, whereby Defendant’s preferred stock in the corporation was “automatically” converted to common stock upon completion of an IPO, was an exempt “reclassification” transaction under the SEC Rules. Conversely, Plaintiff argued that the exemption did not apply. The Court found that the SEC had acted within its power in exempting reclassification transactions from Section 16(b), and that as a result of that exemption, Defendants were entitled to judgment as a matter of law.  More ›

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Court of Chancery Voids Bonus Payments

Valeant Pharmaceuticals International v. Jerney, C.A. No. 19947 (Del. Ch. March 1, 2007).

Payment of bonuses to officers and directors often seems so routine that extra care is not required to be sure they are fair. This case shows what can go wrong when fair process and fair amounts are not properly considered.

Because each member of the board was to receive a bonus under the plan in issue, the bonuses were subject to the rigorous entire fairness review by the Court. That involves testing to see if the process used to approve the bonuses was fair in the sense of using appropriate safeguards to protect the corporation's interests and fair in the sense that the amounts involved were within a range of reasonableness. These bonuses failed on both counts.

To begin with, the committee to whom the bonus plan was referred consisted of persons who would receive a bonus and a majority of the committee were closely allied with the CEO who was targeted for a $30 Million bonus under the plan. The consultant they hired came in after the plan was set up and was really only asked to justify the amounts involved.

Second, the amounts were extremely high compared to other bonuses and were for work that had not just been done already before the plan was announced but that had in a sense already been  the subject of prior bonuses. All in all, this was just too much and the Court voided the bonuses. More ›

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