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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.
Morris James Blogs
Delaware Supreme Court Revives Fiduciary Duty Claims in Derivative Lawsuit Concerning Blue Bell’s Listeria Outbreak
As this decision illustrates, while Delaware law imposes a high bar for pleading demand futility and fiduciary oversight claims under what is known as a Caremark theory, the standards are not insurmountable. After Blue Bell Creameries faced a deadly listeria outbreak, recall, and temporary shutdown a few years ago, a stockholder plaintiff sued in the Delaware Court of Chancery alleging breaches of fiduciary duties by two key executives and its board of directors. The stockholder’s derivative claims concerned management’s alleged failure to respond appropriately to food safety issues and the board’s alleged failure to implement any food safety reporting system or to inform itself about the company’s food safety compliance. More ›
Even when an indemnitee takes a circuitous path to victory, the indemnitee is entitled to indemnification under 8 Del. C. § 145(c) for litigation expenses if the indemnitee is ultimately successful “on the merits or otherwise.” Brown, an officer and director of Rite Aid, sought indemnification under § 145(c), as well as the corporate bylaws and charter, for litigation that spanned from 2002 to 2016 in Pennsylvania. Brown prevailed against Rite Aid in the Pennsylvania litigation on technical defenses. Despite this outcome, Rite Aid sought to limit the amounts to those attributable to Brown's successful technical defense and to exclude amounts attributable to several years of other unsuccessful defenses. But the Court continued its long-standing practice of "look[ing] strictly at the outcome of the underlying action" to determine whether an indemnitee is "successful on the merits or otherwise" under § 145(c). Under this "simple rubric for success," Brown avoided a "personally negative result," so he was entitled to indemnification.
Merger Agreement’s Preservation of Privilege for Pre-Merger Communications Found to be Adequate, Notwithstanding that the Surviving Company Took Possession of E-Mails
This decision confirms that, in a post-merger dispute between an acquirer and the selling stockholders, broad contractual language can prevent a waiver of the acquired company's privileged pre-merger communications, even if the surviving company takes physical possession of the communications. RSI Holdco, LLC acquired Radixx Systems International, Inc. in 2016, and the merger agreement designated Shareholder Representative Services LLC as representative of Radixx's selling shareholders. As part of the merger, RSI Holdco acquired Radixx’s computers and email servers, which contained 1200 pre-merger emails between Radixx and its counsel; Radixx had not excised or segregated the communications from other data. However, the merger agreement contained a detailed provision that (1) preserved Radixx’s privilege, (2) assigned it the representative of selling stockholders, (3) required the parties to take steps to ensure that the privilege remained in effect, and (4) prevented RSI Holdco from relying on the privileged communications in post-merger litigation. In Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, 80 A.3d 155 (Del. Ch. 2013), the Court had found that privilege transferred to the surviving company in a merger as a matter of law pursuant to section 259 of the DGCL because (i) the parties did not address privilege in the merger agreement, and (ii) because the at-issue communications were turned over. Great Hill cautioned future parties to "use their contractual freedom" to exclude privileged communications from the transferred assets. Here, the Court rejected RSI Holdco's argument that the failure to excise the communications waived privilege in this circumstance, and the Court noted that even if the privilege had been waived, the merger agreement still prevented RSI Holdco from relying on the communications in the litigation. Thus, the Court concluded that the sellers "heeded the Great Hill court's advice" and found the detailed provision in the merger agreement preserved the privilege attached to the pre-merger communications.
Delaware courts construe advance notice by-laws against the drafter in favor of stockholder electoral rights. In this case, the defendants had advance notice by-laws that permitted the company to request additional information for certain purposes after receiving notice of a dissident slate of directors, and required a response within 5 days. Pursuant to that by-law, defendants had sent a questionnaire with over 90 questions to the dissident slate. When the dissidents did not supply the requested information within 5 days, defendants advised that their failure to comply resulted in their nominations being defective. The stockholder supporting the dissident slate sued and asked the Court of Chancery to find the nominations complied with the advance notice by-law and to require that the dissidents be freely presented and votes for them counted. Construing the by-law at issue, the Court held that the plaintiff had established that a portion of questions asked exceeded the permissible scope of information requests under the by-laws. Thus, the failure to answer them was not a basis for finding the nominations invalid. The Court therefore ordered that the nominations be presented and that defendants count votes cast for the dissident slate.
Addressing an issue for which there is a split in authority, the Delaware Superior Court held that a Civil Investigative Demand (“CID”) initiated by government authorities will trigger an insurer’s duty to defend and indemnify an insured. After plaintiff Conduent State Healthcare came under investigation for Medicaid fraud, defendant AIG declined to advance defense costs, arguing that the investigation, by itself, did not constitute an insurable claim under plaintiff’s policy. The Superior Court held that the policy language providing coverage for a “Claim alleging a Wrongful Act” extended to the CID. The Court rejected the argument that “investigating an unlawful act by the insured, is different from alleging an unlawful act,” finding that to be a distinction without a difference. The Court relied upon insurance contract interpretation principles and construed the policy against its drafter, holding that the duty to defend and indemnify should be interpreted broadly in favor of coverage.
Seeking to inspect an entity’s books and records to value an investment typically is a proper purpose. But a plaintiff must have standing to demand inspection. More ›
Chancery Addresses the Direct and Derivative Claim Distinction and Demand Futility in the LLC Context
Plaintiff sued Defendants, who were supposed to manage the parties’ limited liability company, directly and derivatively for breaching the LLC agreement, and derivatively for breaching their fiduciary duties. In this decision, the Court of Chancery denies Defendants’ motion to dismiss and addresses, among other things, the direct versus derivative claim distinction under the Tooley test and demand futility under the Aronson v. Lewis test in the LLC context. Here, the LLC managers were deemed interested because they stood on both sides of the challenged transactions—i.e., the allegations that they stole millions from the LLC for themselves, for their other companies, for one of their spouses, and for one of their spouses’ companies. Thus, demand was futile as to the derivative claims, which also adequately stated viable causes of action under less stringent Rule 12(b)(6) standards.
Prior to this ruling, no Delaware opinion had addressed the question of whether decisions granting entitlement to advancement rights are immediately appealable even though disputes remain as to the reasonableness of the fees. This ruling finds the answer normally should be “no.” More ›
The Delaware courts have long tried to balance the public’s right of access to information about judicial proceedings with the legitimate needs of litigants to keep certain information confidential. Rule 5.1 is the Court of Chancery’s codification of the standards and procedures for obtaining, maintaining, and challenging confidential treatment of court filings. Its overarching purpose is to protect the public’s right of access. More ›
Windy City Investments Holdings LLC v. Teachers Insurance and Annuity Association of America f/k/a Teachers Insurance and Annuity Association-College Retirement Equities Fund, C. A. No. 2018-0419-MTZ (Del. Ch. May 31, 2019).
Claims seeking to enforce earn-outs are frequent. Parties often contractually agree that earn-out disputes are subject to an expert determination, rather than litigation in a judicial forum, and courts often dismiss disputes on that basis. This case arises in the somewhat familiar scenario where the parties’ dispute concerns contractual provisions related to, but not subject to, that expert determination, and thus falls within a court’s purview. More ›
The Court of Chancery may appoint a receiver to wind up a deadlocked corporate entity. When that happens, the corporation normally pays the receiver’s fees and expenses. Here, however, the entity was insolvent and unable to pay, and the Petitioner (a 50% owner) opposed contributing to the payment of certain expenses. More ›
The typical claim for breach of fiduciary duty arises out of a single transaction or event, or several closely-related transactions or events. Still, as the Klein decision illustrates, there are circumstances in which the Court of Chancery will find an adequately stated breach of fiduciary duty claim arising out of a course of disruptive conduct. More ›
Chancery Sustains Stockholder Inspection Demands to Investigate Caremark Claims Arising from Facebook / Cambridge Analytica Scandal
A so-called Caremark Claim premised upon disinterested directors' failure to exercise appropriate oversight is one of the most difficult theories to litigate successfully. Here, however, the Court of Chancery held that stockholder-plaintiffs had a sufficient “credible basis” to investigate Facebook’s documents concerning its alleged widespread but secret business practice of “whitelisting” – monetizing the personal data of Facebook users who accessed certain applications on Facebook, as well as that of their Facebook friends. More ›
The absolute litigation privilege is an affirmative defense that bars claims arising from statements made in the course of a judicial proceeding. Here, the Delaware Court of Chancery addressed the scope of the absolute litigation privilege in response to a request for an injunction to bar defendant from prospectively disparaging plaintiff in other litigation. The agreements governing an investment by defendant in the plaintiff’s funds contained confidentiality and non-disparagement clauses. A falling out between the parties resulted in years of protracted litigation in Illinois and Delaware. This Court of Chancery action for breach of confidentiality and non-disparagement clauses in the controlling agreements is based on information disclosed in the prior actions. More ›
Delaware corporate law allows for a corporation to agree in its organizational documents or contracts to advance legal fees and expenses in defense of actions, arising from a person’s service to the company. To encourage quality leadership of companies, the policy under Delaware law is to broadly construe indemnity and advancement provisions in favor of permitting advancement. In its recent decision in Freeman Family v. Park Avenue Landing, C.A. No. 2018-0683-TMR (Del. Ch. April 30, 2019), the Delaware Court of Chancery determined whether a member of a limited liability company was entitled to advancement under the indemnity and advancement provisions of its operating agreement. The operating agreement imposed a duty on the plaintiff to use its best efforts in its capacity as member to either exchange certain real property or have it developed. In the underlying New Jersey suit, for which advancement was sought, the defendant company challenged the plaintiff member’s call rights based on the member’s alleged failure to use its best efforts concerning the property under the operating agreement. More ›