Delaware Business Litigation Report

Court Of Chancery Explains Limits To Guaranty

Roseton OL LLC v. Dynegy Holdings Inc., C.A. 6689-VCP (July 29, 2011)

This decision explains the limits on a parent's guaranty of a subsidiary's performance in the context of what the parent can do with its assets and its ability to later honor the guaranty.  It is an illustration of the need to understand the client's business and for careful drafting of such agreements.

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Court Of Chancery Determines When Discovery Permitted To Vacate Award

Chartis Specialty Insurance Company v. LaSalle Bank,  C.A. 6103-VCN (July 29, 2011)

This decision discusses when a party may obtain discovery in an action seeking to vacate an arbitration award.  The short answer is "not very often."  However, discovery was granted in this case alleging arbitrator bias.

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Court Of Chancery Limits Interim Fee Applications

Frank v. Elgamol, C.A. 6120-VCN (July 28, 2011)

Recently, the Court of Chancery has permitted fee applications before a case is finally decided. This decision notes that practice should and will be limited to unusual situations. That cuts off that trend before it goes too far.

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Court Of Chancery Modifies the Duthie Procedures

Fuhlendorf v. Isilon Systems Inc.,  C.A. 5772-VCN (July 22, 2011)

When a director is sued, he often is entitled to have his attorney fees advanced by his company, even when it is his former company.  A fight over the fees sometimes results, however, when the fees are high and the relationship with the director is not the best.  The Court of Chancery, after having to referee several of these fee fights, adopted what are known as the Duthie  procedures where a percentage of the fees are paid and any disputed fees are sent to a special master to determine reasonableness.  The parties then split the fees of the master.  This decision modifies the Duthie procedures by having the fees of the special master paid by the company and not split with the director when his advancement agreement calls for payment not just of his fees but of any "expenses."

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CCLD Follows Chancery Analysis

ALTA Berkely VI C.V. v. Omneon, Inc., C.A. N10C-11-102 JRS CCLD (July 21, 2011)

On one level this is not a particularly unusual decision and that is just the point.  For here the Superior Court's new CCLD shows that it is going to make the same studied analysis and follow the same precedent as the Delaware Court of Chancery.  This will increase confidence in the CCLD and, as this decision shows, its experienced and competent judges, for business disputes.

The Delaware Supreme Court affirmed this decision on MArch 5, 2012.

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Why You Should Care What Law Applies to Your Contract

This article, authored by Edward M. McNally, was originally published in the Delaware Business Court Insider | July 20, 2011

It is striking how often drafters fail to consider what law applies to the contract they write. This is true of even big contracts. For example, Directors & Officers insurance policies frequently fail to choose the applicable law, leaving the choice of law to depend on where the policy is written or the insured company resides. But to ignore the choice of law is to forego many possible advantages that the right choice may provide. This article touches upon those advantages in the context of two recent decisions where the result turned on the choice of Delaware law.

Choosing the right law for your client will always be the right choice compared to ignoring the issue. First, at least the choice may avoid costly arguments later. People argue over what law applies because it may make a real difference. Those arguments cost real money. Second, if you choose wisely, you will choose in favor of predictability. Trying to decipher the law of some jurisdictions (such as Saudi Arabia) can be very difficult. If you do not know for sure what the applicable law provides, then you do not know if what you wrote in your contract actually works as you thought. Third, you can often simplify a contract by choosing the law that applies. That saves money just in the drafting process alone.

What law, then, should you choose? Better to pick the law you know than to guess at what some other jurisdiction's law might be. That just is common sense. However, two recent decisions illustrate why you might want to consider Delaware law for your next contract. Indeed, Delaware law is now the preferred law in most merger and acquisition documents, even for those not involving a Delaware corporation. In that practice area, Delaware law is considered a neutral compromise when the parties are from different jurisdictions whose laws might otherwise apply but for the contractual choice of Delaware. Delaware M&A law is also well-developed and thus more predictable than the law in some other jurisdiction. More ›

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Supreme Court Explains Duties In Electronic Discovery

Genger v. TR Investors, LLC,  No.  592, 2010 (July 18, 2011)

For years the federal courts have steadily increased the sanctions for not following the rules governing email production in pretrial discovery.  Now the Delaware Supreme Court has affirmed that it too will impose harsh penalties when emails are destroyed.  The opinion has a useful explanation of the rules governing storage of emails and what should be done to protect them.

The opinion also clarifies that a Delaware court may decide who may vote the stock in a Delaware corporation even when the individuals claiming that right are not before the court.  However, the court may not determine who owns that stock unless it has personal jurisdiction over them.

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Court of Chancery Denies Expedited Process in Merger of Limited Partnership Even Though Plaintiff Stated Colorable Claim

Authored by Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | July 13, 2011

The Court of Chancery often hears applications for expedition of a plaintiff's motion to enjoin a merger transaction. While the court "has followed the practice of erring on the side of more hearings rather than fewer" (Giammargo v. Snapple Beverage Corp. (1994)), it will not schedule an expedited hearing unless the plaintiff can show good cause.

The June 10 opinion in In Re K-Sea Transportation Partners L.P. Unitholders Litigation illustrates that, even where a plaintiff can state a colorable claim, the court will not schedule an expedited hearing if the plaintiff fails to show "a sufficient possibility of a threatened irreparable injury, as would justify imposing on the defendants and the public the extra (and sometimes substantial) costs of an expedited preliminary injunction proceeding," (citing Giammargo).

The K-Sea case also illustrates that when parties to agreements governing limited partnerships, limited liability companies or other alternative entities modify or eliminate fiduciary duties, a Delaware court will enforce the agreements as written. Courts will not undo what one party now believes is a bad bargain through the application of fiduciary duties or the implied covenant of good faith and fair dealing.

PARTNERSHIP ACQUISITION

K-Sea involved the acquisition of a Delaware partnership. The acquirer sought to acquire the limited partnership by merger for either cash or a combination of cash and the acquirer's stock. Representatives of the board of directors of target's general partner negotiated the terms of the merger agreement. A special committee approved the transaction.

The plaintiffs argued that the special committee's approval did not comply with the K-Sea Limited Partnership Agreement (LPA) for two reasons. First, the special committee failed to consider separately an $18 million payment to the general partner for its incentive distribution rights (IDRs). Second, the members of the special committee were not independent because shortly before the beginning of merger negotiations with the acquirer, the target granted them each 15,000 phantom units that would immediately vest upon a change of control.

The plaintiff-unitholders also challenged the disclosure provided the common unitholders in the registration statement.

  More ›

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Chancellor Explains How Representations And Warranties Work

GRT, Inc. v. Marathon GTF Technology Ltd., C.A. 5571-CS (July 11, 2011)

One of the more misunderstood aspects of merger agreements is how their representations and warranties are intended to work.  Do they continue after closing?  What is the limit on when litigation may be filed over any breach?  This decision answers those questions and is therefore essential reading for those who deal in these agreements.

Of particular importance is the decision's holding that a 1 year limitation of litigation is binding  and may cut off claims for breach of the representations and warranties.

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Court of Chancery Applies Delaware Law To German Investment

QVT Fund LP v. Eurohypo Capital Funding LLC I,   C.A. 5881-VCP (July 8, 2011)

When will Delaware law apply to a dispute is often not an easy question to resolve.  That is true even when the parties had agreed to sue under Delaware law but the issue presented may involve foreign law as well.  Here the Court sorted through a complicated deal involving the internal affairs of a German bank and held that some of the issues might be governed by German law but the main dispute was subject to Delaware law. This analysis is thus a useful guide in other complicated choice of law situations.

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Unliquidated Derivative Claims Continue to Have Little Value

This article was original published in The Delaware Business Court Insider | 2011-07-06

On May 31, Vice Chancellor Leo E. Strine Jr. issued an opinion denying a motion for preliminary injunction to halt a merger between Massey Energy Company and an affiliate of Alpha Natural Resources Inc. One of the critical issues in the opinion was the value of the derivative claims Massey had against certain current and former directors and officers arising out of Massey's compliance with federal mining safety regulations.

Massey's attitude toward federal mining safety regulations arguably manifested itself in the Upper Big Branch mine disaster, which resulted in the loss of 29 lives. In his opinion, Strine found that the plaintiffs had probably stated a Caremark claim against the directors of Massey and criticized the board of Massey for failing to assess the value of the derivative claims but ultimately refused to enjoin the merger, concluding that the derivative claims did not have the value plaintiffs believed.

While this result has received some negative commentary, is it really a surprise? In fact, the court's analysis is consistent with prior analyses addressing the value of derivative claims in the context of a merger. The fact that the party here is more infamous than many others did not change the analysis under Delaware law.

The plaintiffs valued the derivative claims based on the "aggregate negative financial effect on Massey that the Upper Big Branch Disaster and its Fall-Out has caused." According to the plaintiffs' expert, these damages range from at least $900 million to $1.4 billion. The court, however, rejected this theory, in large part because the computation of the value of the derivative claims was far more complicated than the plaintiffs' theory.

First, even though the plaintiffs had stated a viable Caremark claim against the directors, because of the business judgment rule and the exculpatory provisions in Massey's certificate of incorporation, in order to obtain a monetary judgment against the directors, they would have to prove that the directors acted with scienter — a difficult standard to meet, particularly with independent directors.

Second, the court also found that even as to the autocratic former leader of Massey, Don Blankenship, who was arguably responsible for Massey's approach to mining safety, meeting this standard would be difficult. The court noted that there is a large gap between pushing the limits of federal regulations while accepting minimal loss of life and knowingly endangering the mine itself by putting its very operations at risk. Moreover, Blankenship was not directly in charge of any specific mine, and tying his policies directly to any disaster would be challenging.

Third, proving that the directors acted with scienter may entitle the corporation to a monetary judgment from the directors, but it would simultaneously expose the company to third-party civil liability and potential criminal liability, and potentially deprive the directors of the ability to rely on insurance coverage, all of which would harm the company.

Fourth, after the merger, Alpha will continue to have to address direct claims against Massey from its lost and injured miners, regulatory consequences of the company's mining safety approach, and other elements of the "Disaster Fall-Out." To the extent possible, Alpha will have every incentive to shift that liability to the former directors.

Fifth, it is impossible to determine the potential derivative liability of the directors until Massey's direct liability is determined. Indeed, it is not even in the interest of Massey's stockholders to press their claims of derivative liability now, before third-party civil and criminal adjudication, lest the plaintiffs expose the company to additional liability.

Sixth, the plaintiffs' expert put no value on the ability of the company or its stockholders to collect on a potential $1 billion judgment. The company's insurance policy, even assuming it is available to cover claims against the former directors, is only $95 million. While this is no small amount, it is, as the court put it, "not material in the context of an $8.5 billion merger."

While the vice chancellor was quick to note that the Massey board's approach to valuation of the derivative claims was less than ideal, because of the factors noted above, he found that the plaintiffs had not persuaded him that the merger was unfairly priced because of the failure to value separately the derivative claims. Was this conclusion so unprecedented, however, to justify criticism of the valuation?

Delaware courts previously have been asked to consider the value of unliquidated, contingent claims belonging to the company in the valuation context. These courts have never valued derivative claims at the full value of all potential damages, but instead have considered many of the factors Strine addressed in Massey.

For instance, in Onti Inc. v. Integra Bank Inc., petitioners in an appraisal action argued that their derivative claims should have been valued as an asset of the company in the appraisal proceeding. The stockholders' expert valued the claims at more than $19 million, while the company's expert valued the claims at negative $2.5 million. The court determined that the claims had no value. In reaching that conclusion, the court adopted the theory advanced by the company's expert, that all litigation factors should be considered, including the likelihood of success on the merits, the attorney fees necessary to obtain that result and any indemnification that the company would owe to its directors. Citing to prior precedent, the court noted that "there would be strong logic in including the net settlement value of such claims as an asset of the corporation for appraisal purposes."

Later that same year, the court took a similar approach in Bomarko Inc. v. International Telecharge Inc. The court valued the claim in that case by multiplying the probability of success by the likely amount of recovery while subtracting costs incurred to obtain that result.

More recently, in Arkansas Teacher Retirement System v. Caiafa, the Court of Chancery overruled an objection to a settlement that released claims that the board failed to ascribe any value to federal derivative claims in a merger. After noting that there is no case law supporting the proposition that the board was required to undertake a separate and discrete valuation of the derivative claims pending at the time of the challenged merger, the court reached the same result as Strine did in Massey, albeit with less analysis. That is, the court noted that the claims asserted in the federal action were difficult to win, and even those that had a higher probability of success could not have the $2 billion value the objectors claimed they did. On appeal, the Delaware Supreme Court affirmed the Court of Chancery's decision to overrule the objection for the reasons set forth in the Court of Chancery's opinion.

Given these precedents, is the result in Massey all that surprising? While some contingent claims have been given value, it is the exception, and not the rule, to assign material value to contingent derivative claims. Moreover, in the context of a merger worth billions of dollars, the likelihood is low that derivative claims have material value, particularly when reasonable defenses can be interposed.

But does this decision mean that boards can just eschew any analysis of the value of a derivative claim in the context of a merger? Probably not. The Court of Chancery certainly did not condone the practice, and had the court not been persuaded that the board otherwise acted properly, the failure to do so could have had more importance.

Further, because the exception to the derivative standing rule that entering into a merger for the purpose of extinguishing derivative claims remains viable, particularly in light of the Supreme Court's opinion in Caiafa, failure to value the claims could support the conclusion that a merger was negotiated simply to avoid liability. Finally, not all derivative claims are equal in this context. As Strine noted in Massey, if Massey had a liquidated claim against a former fiduciary reduced to a judgment but failed to get any value for this claim, he could see the substantial unfairness in failing to obtain value for that claim in a merger. Alternatively, if recovery on any derivative claim after a cash-out merger would inure solely to the benefit of the acquirer, then perhaps there would be value to the buyer in obtaining that claim.

Put simply, as with many issues of fiduciary law, the context of the situation is important. What is fairly clear, however, is that unliquidated contingent derivative claims are not ascribed much value, if any, in a merger context, unless a party can demonstrate a reasonable likelihood that the net value of the claim to the company is material.

Peter B. Ladig (pladig@morrisjames.com) is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group. He represents both stockholders and directors in corporate litigation. The majority of his practice is in the Delaware Court of Chancery, although he has extensive experience in the other state and federal courts in Delaware and has been involved in over 50 published decisions. The views expressed herein are his alone and do not necessarily reflect the firm or any of the firm's clients.
 

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Will Delaware Survive Without A William In Charge?

This article was originally published in the Delaware Business Court Insider | June 29, 2011

There is trouble in Delaware.  For over 40 years the esteemed Delaware Court of Chancery has been almost always headed by a Chancellor named “William.”  From William Duffy, to William Marvel to William Quillen to William Allen and last in the line, William Chandler, the Court has been well served by its Williams.  Now that Leo Strine is about to become the rare Chancellor not named William, concern abounds over his name.  Of course, a past great Chancellor was named Grover, as in Grover Brown, but that was the exception that proves the rule.  Apart from their common name, what made all these Williams special?  That answer can be seen in looking at the characteristics of the last William, Chancellor Chandler who has just retired.

First of all, William Chandler was an honest man in an age when intellectual honesty is not common.  By honesty, of course, I do not refer to financial integrity.  All Delaware judges have had that in recent memory.  Instead, honesty means following binding precedent even when you think it is wrong.  Here, Chancellor Chandler always said what he thought and never hid his reasoning, but followed precedent even if he disagreed with the Delaware Supreme Court.

A great judge has intelligence.  The scholarship of so many Chandler opinions is astonishing for a busy judge.  Just look at the hundreds of footnotes in his recent Air Products decision issued soon after the last hearing and you must wonder how did he find the time.  Intellectual ability made the difference.  Past Chancellors such as William Allen have lasting reputations for their scholarship.  So too will this Chancellor Chandler.

A great judge has energy.  Being a judge requires paying attention to witnesses and lawyers droning on and on and then writing an opinion that decides a complicated case.  That takes stamina.  Chancellor Chandler’s frequent jogging kept him in shape and that was reflected in the energy he brought to the job.

A great judge is a good administrator.  The Court of Chancery under this Chancellor was free from internal squabbling, had a hard working staff of reporters and administrators and consistently provided great service.  While that is a tribute to that staff, it also reflects well on the person in charge – the Chancellor.  This aspect of the job is often overlooked because it is not done in public or with great fanfare.  Yet, it is vital to an effective court.  Moreover, Chancellor Chandler has a great interest in technology.  That has led the Court to be up-to-date not just with electronic fillings but with other innovations such as easy rapid transcription of hearings. 

A great judge has patience.  Chancellor Chandler is among the most patient of human beings.  He was patient with wandering lawyers, pro se litigants, impossible deadlines and constant demands on his time with rarely a complaint.  This characteristic is much more appreciated than some judges might think.  Chancellor Duffy was a small man in stature, but had total command of the Courtroom through his calm, patient demeanor.  Not for him was the sarcastic remark to put down the wrongheaded lawyer.  Chancellor Duffy instead would gently show the errors of that lawyer’s position by his patient explanations.  That is not easy and is often not acknowledged, but is important.  Chancellor Chandler had a similar quiet but effective command of his courtroom.

A great judge is a good listener.  This is more than just being patient.  It is the knack of making the person talking to you feel that you are hearing and considering every word they say.  Chancellor Chandler was the best listener I have ever seen.  He made you feel that you were the only one in the room.  On occasion at some Bar or judicial event, the Chancellor would need to participate in a conference call.  When he did, the telephone literally seemed to be part of his anatomy and even if a streaker ran by he would not blink so intent was his concentration.

A great judge is a faithful public servant.  The Court of Chancery did not need to volunteer to hold mediations and now arbitrations of business disputes in addition to its regular, full docket.  But to keep Delaware as a leader in resolving business disputes, this Chancellor was an early advocate of these additional services to business litigants.  That is a burden that he and the Court took on and that is all done in private without any public appreciation for that extra effort.  That is real public service.

Finally, a great judge enjoys his job.  The constant clamor of litigants and the demands of always being “fair” can make any judge irritable.  That never happened with Chancellor Chandler.  Sure he always ruled his courtroom and could be stern when that was needed.  But day in and day out he was good to be with even in the toughest trial.  Just the joy he took in the new courthouse in Georgetown was a pleasure to see, including giving tours of that courthouse when it first opened.

So what about the nominee to be Chancellor?  Even though he is named “Leo” he is well-suited for this job as Chancellor.  While not as patient as Chancellor Chandler (who is anyway?), Chancellor Strine has the intellectual honesty, intelligence, energy, administrative skills, and commitment to public service of the Williams who preceded him.  The Delaware Bar expects that he will fulfill his promise.
 

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Court Of Chancery Explains Attorney Fee Awards

In re Del Monte Foods Company Shareholders Litigation, C.A. 6027-VCL (June 27, 2011)

This is another in a series of detailed explanations of how attorney fees are to be calculated in representative litigation in Delaware.  First, the Court explained when an interim application may be considered, noting that it may be preferable to do so when the matter is still fresh.  That is particularly so when any appellate review is not likely to change the benefit conferred by the litigation.

Next, the Court explained that uncovering facts not known before the litigation began is particularly important and deserving of a fee award at the higher end.

Finally, the Court set out examples of prior fee awards and explained how those informed its decision in this case.

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Lewis Lazarus Authors Article on Plaintiffs' Pleading Burden in the Court of Chancery

Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | June 15, 2011

A plaintiff who pleads successfully that a transaction under attack is governed by the entire fairness standard of review instead of business judgment generally stands a good chance of defeating the defendant's motion to dismiss.  That is because when a transaction is reviewed for entire fairness, defendants bear the burden in the first instance of proving at trial the fairness of the process and price.

In two recent cases - Ravenswood Investment Co. v. Winmill and Monroe County Employees' Retirement System v. Carlson - the Court of Chancery clarifies that a plaintiff must still make well-pleaded allegations that a transaction is unfair as to process and price if its complaint is to survive dismissal at the pleadings stage.

Ravenswood involved claims that defendant directors' adoption of a performance equity plan violated fiduciary duties by seeking to dilute the minority stockholders' percentage interest in non-voting Class A shares (only Class B shares had voting rights).  The court noted that the entire fairness standard applied because "where the individuals comprising the board and the company's management are the same, the board bears the burden of proving that the salary and bonuses they pay themselves as officers are entirely fair to the company unless the board employs an independent compensation committee or submits the compensation plan to shareholders for approval."

Because the directors employed no such protective measures, the court held that the entire fairness standard of review applied.  Still, citing Monroe County, the court held that the plaintiff "bears the burden of alleging facts that suggest the absence of fairness."

The court dismissed the plaintiff's complaint because it found he had failed to make well-pleaded allegations that the defendant directors' adoption of the performance equity plan was unfair.  Critical to the court's reasoning was that dilution occurs upon the adoption of any options plan; the question is whether the manner in which the options were issued unfairly diluted the stockholders.

As the defendants in their motion to dismiss did not challenge the plaintiff's claim for unfair issuance of the options, the court found that the plaintiff's allegation of dilution did not suffice to state a claim for unfairness in the adoption of the performance equity plan.

This was so because the plaintiff alleged that "(1) the Performance Equity Plan only authorizes the Board to grant stock options with an exercise price not lower than the market value as of that event, (2) the Defendants already control all of the Company's voting rights through their ownership of its Class B shares, and (3) even if all options authorized under the plan were to be granted to the Defendants they would not obtain a majority interest in the Class A shares... ."

The court noted that although it was true that the Class A shares could vote to approve a merger, the plaintiff made no allegation in his complaint that the adoption of the performance equity plan impaired those voting rights.  The court declined to comment on whether such an allegation may have sufficed to sustain this claim.

The Ravenswood court relied upon the court's holding in Monroe County.  That case involved a challenge to an intercompany agreement that required the plaintiff's company to purchase services and equipment from its controlling shareholder on terms in conformity with (for services) or the same as (for equipment) what the controlling shareholder charged its other affiliates.  The parties agreed that the arrangement the plaintiff attacked was governed by the entire fairness standard of review.

They disagreed as to whether the plaintiff's pleading sufficed to survive a motion to dismiss.

As summarized by the court: "Delaware law is clear that even where a transaction between the controlling shareholder and the company is involved such that entire fairness review is in play, plaintiff must make factual allegations about the transaction in the complaint that demonstrate the absence of fairness. (citations omitted).  Simply put, a plaintiff who fails to do this has not stated a claim.  Transactions between a controlling shareholder and the company are not per se invalid under Delaware law. (citation omitted).  Such transactions are perfectly acceptable if they are entirely fair, and so plaintiff must allege facts that demonstrate a lack of fairness."

In reviewing the complaint, the court found no allegations that the price at which the controlling stockholder provided the services and equipment was unfair.  Instead, the court found that plaintiff's allegations addressed only alleged unfair dealing.

In the absence of an allegation that the company could have obtained the services or equipment on better terms from a third party or any specific allegation of the worth of the services or equipment relative to what the company paid, the court found that the complaint did not make sufficient factual allegations that the intercompany agreement transactions were unfair.  Because the plaintiff chose to stand on its complaint in response to the defendants' motions to dismiss rather than to amend, the court dismissed plaintiff's complaint with prejudice under Court of Chancery Rule 15(aaa).

Together, these two cases clarify that a plaintiff cannot survive a motion to dismiss simply by alleging that a transaction involving a controlling stockholder is unfair.  A plaintiff instead must make particular factual allegations suggesting why the transaction was unfair.  A plaintiff who cannot make such allegations and who stands on a conclusory complaint, as in Ravenswood, may find that its claims are dismissed with prejudice.

Lewis H. Lazarus (llazarus@morrisjames.com) is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group.  His practice is primarily in the Delaware Court of Chancery in disputes, often expedited, involving managers and stakeholders of Delaware business organizations.  The views expressed herein are his alone and do not necessarily reflect the firm or any of the firm's clients.
 

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Delaware Supreme Court Upholds Insider Trading Remedy

Kahn v Kolberg Kravis Roberts & Co. L.P., No.  436, 2010 (June 20, 2011)

One of the more important fiduciary duties in Delaware corporate law is not to trade on insider information.  A complaint alleging that you did is known as a Brophy claim for the decision that announced it over 60 years ago.  Recently, Brophy was thought to have been watered down by a requirement that the company actually suffer harm from the trading involved.  That would occur, for example, if the company is in the market to buy back its own stock in competition with the insider.

Well, the Supreme Court announced in this decision that it will not permit any chipping away at the Brophy rule.  It is not necessary to show harm to bring such a claim.  Rather, preserving the sanctity of fiduciary duties under Delaware law warrants permitting recovery of any profits made by the disloyal fiduciary, even if not at the company's expense.

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