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 meaningfully changed Delaware law or provided clarity or guidance on issues relevant to corporate and commercial litigation in Delaware. We present the decisions in no particular order. The list does not include every significant decision, but provides litigants and litigators with an array of decisions on varied issues likely to affect business transactions or business litigation.
One: Marchand v. Barnhill, 212 A.3d 805 (Del. 2019) (Strine, Chief Justice); In Re Clovis Oncology, Inc. Derivative Litigation, 2019 WL 4850188 (Del. Ch. Oct. 1, 2019) (Slights, Vice Chancellor).
Under In re Caremark Intern. Inc. Derivative Litigation, 698 A.2d 959, 969 (Del. Ch. 1996), the duties owed by directors of a Delaware corporation include the obligation to monitor operations, meaning to implement and oversee information and reporting systems and controls. But Delaware courts have long recognized that a Caremark theory of liability is one of the most difficult theories in corporate law for a stockholder plaintiff to plead and prove. That is because a plaintiff generally must pursue a theory of bad faith, which involves the board either utterly failing to implement any systems or controls or consciously failing to oversee their operation. Marchand and Clovis are significant because they illustrate the type of allegations that will enable a Caremark theory to survive dismissal.
Marchand arose out of a listeria outbreak, recall, and temporary shutdown involving Blue Bell Creameries and resulting derivative claims concerning the board’s alleged failure to implement food safety controls. Defendants successfully moved to dismiss at the trial court level, but the Delaware Supreme Court reversed. Important to the Supreme Court’s decision to revive the Caremark claims was the mission-critical nature of the board’s alleged failure to oversee food safety at a regulated ice-cream company. As the Supreme Court articulated, Caremark has an important “bottom-line” requirement: “the board must make a good faith effort—i.e., try—to put in place a reasonable board-level system of monitoring and reporting." And in this case the Supreme Court found sufficient facts from which to infer that the directors “made no effort” in that regard, citing, among other allegations, the lack of regular process or protocols requiring board-level reporting of food safety issues, and the absence of any record evidencing regular board-level discussion on the topic. According to the Supreme Court, these allegations supported an inference of failed oversight for “one of the most central issues at the company: whether it is ensuring that the only product it makes—ice cream—is safe to eat.” Further, the company’s nominal compliance with FDA regulations through management’s efforts could not cure the alleged oversight shortcomings at the board-level.
Clovis concerned a biopharmaceutical company with one especially promising drug among its products that it was unable to bring to market following misreporting of the drug’s efficacy during clinical trials. The Court of Chancery, relying on Marchand, denied defendant’s motion to dismiss Caremark claims. As in Marchand, important to the Court’s ruling was the mission-critical nature of the relevant drug and the regulatory environment in which the company operated. According to the Court, “[a]s Marchand makes clear, when a company operates in an environment where externally imposed regulations govern its ‘mission critical’ operations, the board’s oversight function must be more rigorously exercised.” While Caremark “does not demand omniscience” in this regard, “it does demand a ‘good faith effort to implement an oversight system and then monitor it,’” which “entails a sensitivity to ‘compliance issue[s] intrinsically critical to the company.’” In this case, the Court found sufficient facts from which to infer that the directors failed to monitor the company’s oversight system, citing the board’s ignorance of alleged warning signs that management was inaccurately reporting the drug’s efficacy and violating established protocols.
Key Takeaway: Notwithstanding the high bar to plead a Caremark theory, a set of particularized allegations showing serious oversight shortcomings regarding a mission-critical topic can succeed.
Two: Olenik v. Lodzinski, 208 A.3d 704 (Del. 2019) (Seitz, Justice).
Mergers involving a corporation and its conflicted controlling stockholder invoke Delaware’s most stringent form of judicial scrutiny, i.e., entire fairness review. But, with the right procedural protections in place, at the right time, even those transactions can get the benefit of Delaware’s deferential analysis, i.e., business judgment review. Under Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”), a conflicted controller transaction may get the benefit of business judgment review when conditioned on two procedural protections involving approval by (i) an independent special committee and (ii) a majority of the minority stockholders. MFW includes a critical timing requirement: its dual protections cannot be tacked on mid-negotiation; they must be imposed “ab initio,” i.e., “from the beginning.” In Flood v. Synutra, 195 A.3d 754 (2018), the Delaware Supreme Court clarified that MFW’s protections need not be part of the first expression of interest. Rather, it is enough that they are in place early and before substantive economic negotiations occur. Olenik represented the next word from the Delaware Supreme Court on MFW’s timing requirement.
The Delaware Supreme Court on appeal in Olenik found that the complaint permitted a reasonable inference that the buyer established MFW protections too late to obtain business judgment review. In doing so, the Court reaffirmed Synutra, explaining “[t]he Court of Chancery held correctly that preliminary discussions between a controller’s representatives and representatives of the controlled company do not pass the point of no return for invoking MFW’s protections.” Here, however, several allegations gave rise to a reasonable inference that the MFW conditions came after the parties engaged in substantive economic discussions. One of the most critical allegations supporting that inference concerned the parties’ decision to engage in a joint valuation exercise before imposing the MFW conditions. That exercise, according to the Supreme Court, arguably “set the field of play for the economic negotiations to come by fixing the range in which offers and counteroffers might be made.” Because the parties’ substantive economic discussions occurred before the parties adopted the MFW protections, MFW was inapplicable and entire fairness would remain the standard of review.
Key Takeaway: Under Synutra, MFW’s protections must be adopted early and before substantive economic negotiations start. Under Olenick, several months in and after exchanging valuations likely is too late.
Three: KT4 Partners LLC v. Palantir Technologies, Inc., 203 A.3d 738 (Del. 2019) (Strine, Chief Justice).
Under Section 220 of the Delaware General Corporation Law (“DGCL”), a stockholder has a qualified right to inspect corporate “books and records” that are necessary to fulfill the stockholder’s proper purpose, such as valuing one’s shares or investigating colorable claims of suspected mismanagement. The scope of such an inspection and the type of documents attainable generally is a case-by-case determination. Several Court of Chancery decisions in recent years have found that inspections may extend to electronic communications under the right circumstances. KT4 Partners represented the Delaware Supreme Court’s first input on that issue.
KT4 Partners involved a stockholder’s investigation surrounding suspect amendments to an investor rights’ agreement. The Court of Chancery had denied inspection of emails on the subject, but the Delaware Supreme Court reversed. The Supreme Court’s holding was pragmatic and based on the relevant company’s failure to respect corporate formalities, and the unavailability of more typical corporate records on the subject, such as board meeting minutes, resolutions, and official letters. The Supreme Court reasoned that a corporation observant of traditional formalities helps guard itself against more intrusive inspections encompassing electronic communications. But one that shuns such formalities in favor of conducting its affairs through informal electronic communications, like the defendant in this case, “cannot use its own choice of medium to keep shareholders in the dark about the substantive information to which [Section] 220 entitles them.” Further, in affirming that books-and-records inspections may reach electronic communications, the Supreme Court also clarified the burden of proof placed on stockholders seeking them. The Supreme Court declined to adopt a heightened “compelling” evidence requirement, requiring only some evidence that emails are necessary to achieving the stockholder’s purpose.
Key Takeaway: Under KT4 Partners, corporations interested in preventing electronic communications from coming within the scope of books-and-records inspections would be well-served to respect traditional corporate formalities in executing board-level action and to document those efforts.
Four: Tiger v. Boast Apparel, Inc., 214 A.3d 933 (Del. 2019) (Traynor, Justice).
Confidentiality agreements or orders restricting the use of information produced in response to a stockholder books-and-records demand have become commonplace. Like KT4 Partners discussed above, Tiger offers additional clarification from the Delaware Supreme Court on stockholder inspection rights under Section 220 of the DGCL, this time specific to the issue of confidentiality.
In Tiger, while affirming the Court of Chancery’s final order and judgment in a Section 220 action, the Supreme Court took the opportunity to observe the development of a trial court-level rule that books and records produced pursuant to Section 220 are presumptively entitled to reasonable confidentiality restrictions. The Supreme Court clarified that while the Court of Chancery may, and often does, condition inspection of non-public information on reasonable confidentiality restrictions in the exercise of its discretion, no presumption exists in favor of confidentiality. Rather, to determine the degree and duration of any confidentiality, the Court of Chancery must apply a balancing test that weighs “the stockholder’s legitimate interests in free communication against the corporation’s legitimate interests in confidentiality.” In this regard, while a corporation does not need to show “specific harm” that would result from disclosure before receiving confidentiality, the trial court also must not “reflexively” impose confidentiality restrictions. Following from its central holding, the Supreme Court also clarified that no presumption exists in favor of confidentiality terms continuing indefinitely. According to the Supreme Court, securing anything less than an indefinite confidentiality period is not contingent on the stockholder showing “exigent circumstances.” Indeed, “an indefinite period of confidentiality protection should be the exception and not the rule.
Key Takeaway: While corporations may receive reasonable confidentiality restrictions for non-public books and records produced pursuant to Section 220, under Tiger, absent some agreement among the parties, the corporation should be prepared to offer some evidence to support that entitlement.
Five: Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., 210 A.3d 128 (Del. 2019) (Per Curiam).
Delaware law makes available appraisal rights in certain merger transactions, meaning a statutory process under Section 262 of the DGCL allowing stockholders to forgo a merger’s financial consideration in favor of a judicially-determined appraisal of “fair value.” Delaware courts have long made clear that the deal price for a company, while a relevant factor, does not necessarily equate to the “fair value” petitioners are entitled to receive in an appraisal proceeding.
This opinion arose out of the appraisal proceeding relating to Hewlett-Packard’s purchase of Aruba Networks, which led to two notable opinions from the Court of Chancery. See Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., 2018 WL 922139 (Del. Ch. Feb. 18, 2018) (Laster, Vice Chancellor) (post-trial decision), and 2018 WL 2315943 (Del. Ch. May 21, 2018) (denial of reargument). The Court of Chancery decisions in Aruba Networks came on the heels of the Delaware Supreme Court’s reversals in DFC Global Corporation v. Muirfield Value Partners, L.P., 172 A.3d 346 (Del. 2017) (Strine, Chief Justice) and Dell, Inc. v. Magnetar Global Event Driven Master Fund Ltd., 177 A.3d 1 (Del. 2017) (Valihura, Justice). DFC and Dell reaffirmed that the deal price for an arm’s-length transaction achieved after a thorough sale process likely will be the best evidence of fair value in an appraisal proceeding, from which any synergies must be deducted. In Aruba Networks, however, the Court of Chancery chose not to defer to the merger price. Rather, attempting to discount for synergies arising from the expectation of the merger, the Court determined Aruba Networks’ fair value using the thirty-day average unaffected market price, a price well below the deal price. The decision was widely-reported and hotly-debated.
Here, the Delaware Supreme Court reverses that determination on appeal. Specifically, the Supreme Court in Aruba Networks held that the trial court abused its discretion in relying on the company’s pre-announcement stock price as the best evidence of fair value under the circumstances, concluded that the deal price was better evidence of fair value, and directed the trial court to enter judgment at a specific deal-price-less-synergies valuation figure computed by the Supreme Court. In doing so, the Supreme Court reaffirmed its holdings in DFC and Dell concerning the evidentiary weight of market-tested deal prices, explained the proper application of those decisions, and provided important guidance concerning how a trial court should account for synergies when computing fair value.
Key Takeaway: Under Aruba Networks, Delaware’s “long history of giving important weight to market-tested deal prices” in appraisal litigation continues.
Six: Tornetta v. Musk, 2019 WL 4566943 (Del. Ch. Sept. 20, 2019) (Slights, Vice Chancellor)
Delaware law generally applies deferential business judgment review to executive compensation decisions by a corporation’s board of directors. And, under Corwin v. KKR Financial Holdings LLC, 125 A.3d 304 (Del. 2015), fully-informed and uncoerced approval of a board decision by the corporation’s disinterested stockholders can downgrade an otherwise heightened standard of review to business judgment. On the other hand, Delaware law generally imposes heightened entire fairness scrutiny for transactions that uniquely benefit a controlling stockholder—i.e., the “800-pound gorilla” in the room. And, under the aforementioned MFW decision, a board may secure business judgment review of a conflicted controller merger if it employs dual protections involving (i) an independent special committee and (ii) a majority-of-the-minority stockholder vote. This decision, involving the electric vehicle company Tesla and its CEO Elon Musk, is the first to address the appropriate standard of review when an executive compensation decision benefits the company’s controlling stockholder, and the stockholders approve it.
According to Tornetta, an executive compensation decision benefiting an alleged controlling stockholder invokes entire fairness review by default, and stockholder approval alone will not reduce the standard to business judgment. Significantly, in reaching this conclusion, the Court of Chancery found that MFW’s dual-protection requirement extends to the executive compensation context while declining to limit MFW to “transformational” transactions where the DGCL requires approval by the corporation’s board and its stockholders. The Court’s reasoning returned to “first principles” and relied on Delaware law’s long-standing presumed suspicion of dealings involving conflicted controllers. The Court found no reason to discount that wariness in the executive compensation context. In the Court’s view, a controller’s influence in negotiating self-interested compensation “is no less present, and no less consequential” than in the transactional context. Thus, only MFW’s dual protections would suffice to counteract that coercive threat and invoke business judgment review.
Key Takeaway: Under Tornetta, a board of directors hoping to obtain business judgment review for an executive compensation decision benefitting a controller needs to timely employ and satisfy MFW’s dual protections.
Seven: In re BGC Partners, Inc. Derivative Litig., 2019 WL 4745121 (Del. Ch. Sept. 30, 2019) (Bouchard, Chancellor).
Under Delaware law, a derivative claim for harm to the corporation is a corporate asset that the directors have the right to control unless half or more of them lack impartiality on the claim’s subject. Following from that premise, a stockholder wishing to pursue a derivative claim faces a choice. The stockholder’s first option is to make a pre-suit demand on the board to take action concerning the claim, and in consequence concede that a majority of the board is disinterested and independent on the claim’s subject. Alternatively, the stockholder may try sufficiently to plead that a demand would be futile because a majority of the board is personally interested in or lacks independence from an interested party on the claim’s subject. A common path on the alternate course is to establish demand futility by pleading significant personal or professional ties between the directors and one or more interested parties.
As BGC Partners observes, the standards governing director independence in the demand futility context is a recently-refined aspect of Delaware law. In the preceding four years, the Delaware Supreme Court reversed findings of director independence by the Court of Chancery three different times. See Marchand v. Barnhill, 212 A.3d 805 (Del. 2019); Sandys v. Pincus, 152 A.3d 124 (Del. 2016); Delaware County Employees Retirement Fund v. Sanchez, 124 A.3d 1017 (Del. 2015). According to the Court in BGC Partners, these reversals “reinforce the importance of considering a plaintiff’s factual allegations holistically and affording the plaintiff all reasonable inferences.” Arguably, the decisions reflect a heightened sensitivity by the Delaware Supreme Court to the significance and potential influence of personal relationships on fiduciary decision-making. Applying the Supreme Court’s recent guidance to this case, the Court found that demand was futile, relying on a “constellation” of facts concerning long-standing personal and professional ties between the alleged controlling stockholder (Howard Lutnick of Cantor Fitzgerald) and the relevant directors. Those ties concerned, among other things, consistent directorship appointments by the controller and extensive joint service to a particular college (Haverford College).
Key Takeaway: BGC Partners illustrates the type and degree of personal relationships that may excuse the pre-suit demand requirement and permit a stockholder to pursue derivative claims.
Eight: High River Limited Partnership v. Occidental Petroleum Corp., 2019 WL 6040285 (Del. Ch. Nov. 14, 2019) (Slights, Vice Chancellor).
Once again, Section 220 of the DGCL grants stockholders a qualified right to inspect the corporate books and records that are necessary to satisfy a “proper purpose.” Investigating potential corporate wrongdoing or mismanagement by fiduciaries is a well-established proper purpose. But simply expressing an investigating purpose will not support an inspection. Rather, a stockholder must first establish a “credible basis” justifying the investigation. Relevant to this decision, the Court of Chancery has at times allowed a stockholder to use the fruits of an inspection to assist a proxy contest.
High River addressed a novel “proper purpose” theory posited by the plaintiff that would authorize inspections relating to questionable, but not actionable, board-level decisions so long as the demanded documents would be material to waging a proxy contest. Importantly, while largely distinguishing the plaintiff’s proffered authority on the issue, the Court did not rule out the possibility that the Court of Chancery might validate the theory under the right set of circumstances. Indeed, the Vice Chancellor acknowledged this aspect of Delaware law could benefit from some clarity. Here, however, the Court resolved the case at bar applying more rudimentary principles. Specifically, the Court found that the requested documents were not necessary to the stockholder’s proxy contest purpose because the stockholder already had sufficient information to fulfill that purpose. Relevant to the Court’s conclusion was the widely-publicized nature of the challenged transactions and the plaintiff’s already-demonstrated ability to attack the wisdom of the board’s decision making.
Key Takeaway: The Court’s hesitation to validate a “proxy contest” proper purpose might be news to some who have read Delaware precedent differently. Considering High River, a stockholder wishing to obtain books and records to support a proxy contest probably would be best served to also state and support one or more alternate and recognized proper purposes.
Nine: Channel Medsystems, Inc. v. Boston Scientific Corp., 2019 WL 6896462 (Del. Ch. Dec. 18, 2019) (Bouchard, Chancellor).
Material adverse effect clauses in merger agreements—often referred to as MAE clauses—provide a limited form of buy-side protection. These generally are complex provisions that permit the buyer to terminate a transaction under the right set circumstances. Those circumstances usually involve the discovery of an actual, or reasonably expected, serious deterioration in the target’s business. Historically, an MAE has been very difficult to prove under Delaware law. But the Court of Chancery’s recent decision in Akorn, Inc. v. Fresenius Kabi AG, 2018 WL 4719347 (Del. Ch. Oct. 1, 2018), aff’d 198 A.3d 724 (Del. 2018) represented a high watermark. It was the first Delaware decision to uphold a buyer’s termination based on an MAE. Akorn involved a rather extreme set of facts supporting an MAE, with a drastic and sustained business downturn, whistleblowers, and serious regulatory violations. Still, some questioned whether Akorn signaled a shift in Delaware law or would open the floodgates of MAE litigation.
Channel Medsystems was the next word from the Delaware courts on interpreting and applying an MAE clause, and may somewhat squelch those fears. The event giving rise to the claimed MAE in Channel Medsystems involved the target, an early-stage medical device company, discovering that one of its officers falsified certain records in a self-interested scheme, causing the company to submit misinformation to the FDA concerning its core product in development. Unlike in Akorn, the Court of Chancery held that the buyer’s termination of the merger agreement was invalid because the misconduct did not have, nor was reasonably expected at the time of termination to have, a material adverse effect. In reaching its conclusion, the Court followed Akorn and earlier Delaware precedent in defining a material adverse effect as one that “substantially threaten[s] the overall earnings potential of the seller in a durationally-significant manner.” Applied here, however, the officer’s misconduct did not meet that test. Relevant to the Court’s decision was the target’s remediation efforts after learning of the officer’s fraud, which neutralized the potential negative effects on earnings and resulted in FDA premarket approval for the implicated product.
Key Takeaway: After Akorn, MAEs under Delaware law are no longer mythical creatures. But, as demonstrated by Channel Medsystems, they remain difficult to prove.
Ten: City of Tamarac Firefighters’ Pension Trust Fund v. Corvi, 2019 WL 549938 (Del. Ch. Feb. 12, 2019) (McCormick, Vice Chancellor).
Once again, stockholders seeking recourse on a derivative claim for harm to the corporation have two options: either make a pre-suit demand on the board or bring suit yourself while alleging that demand would be futile. As this decision explains, each route is a “steep road.” A derivative suit faces a heightened pleading standard to justify side-stepping the board’s presumed authority over corporate claims. Specifically, the stockholder must allege particularized facts supporting an inference that at least half of the board members cannot disinterestedly and independently consider the suit’s subject matter. On the other hand, making a pre-suit demand instead of suing concedes that a majority of the full board is capable of impartially considering the suit’s subject matter. Then, if the board ultimately refuses the demand, the stockholder has limited recourse. In any subsequent suit the stockholder must sufficiently allege that the board’s refusal itself was wrongful. Establishing wrongful refusal requires particularized allegations that the board acted with gross negligence or bad faith in rejecting the demand. That standard generally is even more difficult to overcome than pleading demand futility in the first place, making the pre-suit demand route the “steeper road."
Tamarac arises in this context and explains just how far a stockholder’s concession in making a pre-suit demand goes. Here, the stockholder made two pre-suit demands and, in response, the full board formed a special committee of directors which considered and rejected them. The company argued in the ensuing lawsuit that, in light of the stockholder’s demands and tacit concession under Delaware law, the stockholder could not challenge the board’s delegation as grossly negligent and evidence of bad faith. The Court of Chancery disagreed. Reviewing Delaware Supreme Court authority, the Court held that a stockholder making a pre-suit demand concedes only that a majority of the board is capable of disinterestedly and independently considering the suit’s subject matter. The stockholder’s concession does not extend to each director individually. Nor does the stockholder concede that the board will in fact act in disinterested and independent manner. Accordingly, when a board delegates consideration of a pre-suit demand to a committee, a stockholder retains the right to argue that, while there may have been enough disinterest and independence among the full board to consider the demand that is not necessarily true with respect to the committee members. And the stockholder may attack the board’s delegation as grossly negligent or evidence of bad faith when attempting to show the demand was wrongfully refused.
Key Takeaway: Under Tamarac, a stockholder’s pre-suit demand does not concede the disinterestedness and independence of all directors for all purposes and board conflicts may continue to be relevant to a wrongful refusal analysis.