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Summaries and analysis of recent Delaware court decisions concerning business-related litigation.
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Directors Designated By Investors Owe Fiduciary Duties to the Company as a Whole and Not to the Designating Investor
This article was originally published in The Delaware Business Court Insider | 2011-03-23
Investors who make substantial investments often demand a seat on their company’s board of directors. That is a reasonable request as it permits the investor to have a representative on the board of directors with a voice in management of the company. It is well-settled that directors elected by stockholders of a Delaware corporation owe fiduciary duties to the company and all its stockholders once they serve on the board. Thus, they may make decisions in the exercise of their fiduciary duty that are different than what is in the best interest of designating investor. The Court of Chancery’s recent decision in Air Products and Chemicals, Inc. v. Airgas, Inc., 2011 WL 519735 (Del. Ch. Feb. 15, 2011) reflects this issue.
Air Products had sought to acquire control of Airgas since October, 2009. When Airgas rebuffed its inquiries, Air Products launched a hostile tender offer. One of the conditions of its tender offer was that Airgas lift its poison pill. The poison pill made it prohibitively expensive for Air Products to proceed. Airgas refused to lift the pill on the ground that the Air Products offer was inadequate.
Frustrated by its inability to proceed with a tender offer, Air Products nominated three directors to the Airgas board. It stated that its nominees would be impartial in their evaluation of the Air Products tender offer, although they would be replacing Airgas directors who had voted to maintain the Airgas poison pill. Air Products succeeded and its three nominees were elected by the Airgas stockholders to the Airgas board. Once they were on the board of Airgas, the Air Products designees obtained their own legal and financial advisors. Based in part on the advice of their advisors and on their own assessment of the business plans of Airgas, these Air Products nominated directors determined that the Air Products offer was inadequate and voted with their colleagues to maintain the Airgas poison pill.
In so acting, these directors acted consistently with Delaware law. As stated in Phillips v. Insituform of N. Am., Inc., 1987 WL 16285, at *10 (Del. Ch. Aug. 27, 1987) the “law demands of directors … fidelity to the corporation and all of its shareholders and does not recognize a special duty on the part of directors elected by a special class to the class electing them.”
While the Airgas directors’ conflict arose in a highly-publicized battle for control of a public company, issues also arise in privately held companies where investors often condition their investment on the receipt of preferred stock and board representation.
For example, in In re Trados Incorporated Shareholder Litigation, 2009 WL 2225958 (Del. Ch. July 24, 2009), the Court of Chancery sustained a complaint on behalf of a class of stockholders who complained that directors designated by preferred stockholders, constituting a majority of the board, had interests that diverged from the interests of the common stockholders in approving a sale transaction. This divergence arose because the preferred stockholders received a substantial portion of their liquidation preference from the sale, while common stockholders received nothing. The preferred stockholder designated directors also held interests in entities which held preferred stock of the selling company. Those relationships bore on the court’s decision to treat the preferred stock designees as having interests potentially different from, and in conflict with, the interests of the common stockholders. As a result of this finding, the court denied a motion to dismiss because the plaintiffs’ allegations were sufficient to rebut the presumption of the business judgment rule.
These cases teach that directors designated by particular stockholders or investors owe duties generally to the company and all of its stockholders. Where the interests of the investor and the company and its common stockholders potentially diverge, the directors cannot favor the interests of the investor over those of the company and its common stockholders.
Conflicts also are likely to arise over the use of confidential information supplied to the designated directors. Designating directors who owe their livelihood or materially benefit from relationships with the designating investor sharpens the likelihood of conflicts of interest. Companies, investors and directors and their counsel should consider carefully the implications of directors designated by particular stockholders serving on boards of Delaware corporations.
Court Of Chancery Explains Confidentiality Limits
Espinoza v. Hewlett-Packard Company, C.A. 6000-VCP (March 17, 2011)
Occasionally a complaint or other document is filed under seal in the Court of Chancery. This decision explains how to do that and the limits on confidentiality you can expect. As the courts are public institutions with a need to have their proceedings out in the open, the short answer is that do not expect much to remain confidential no matter how embarrassing it may be to you or your client.
ShareCourt Of Chancery Explains Valuation Technique Preferences
S. Muoio & Co. v. Hallmark Entertainment Investments Co., C.A. 4729-CC (March 9, 2011)
There are several different ways to value an enterprise. For a while, discounted cash flow seemed to be the courts' preference. Then when the markets were thought to be "efficient," market values were given weight. This opinion is a good example of the current state of flux where the Court is inclined to take into account all approaches, test to see if there are any outliers, look at the business realities involved and thoroughly analyze the parties' contentions before reaching a determination. In short, it no longer is as simple as it once was and the new business world we live in seems to warrant that approach.
ShareJustice Jacobs and Others Analyze Hostile Takeovers in Developed and Emerging Markets
In the most recent issue of the Harvard International Law Journal, John Armour, Justice Jacobs and Curtis Milhaupt analyze how hostile takeovers arise under similar circumstances in different countries and how countries enact substantially different regulatory responses to hostile takeovers. The article focuses primarily on hostile takeovers in the United States, United Kingdom and Japan, but also considers the possible trajectory of hostile takeovers in emerging markets like China, India and Brazil.
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Court Of Chancery Explains Right To Inspect After Demand Refused
This decision explains why a stockholder is entitled to inspect the documents surrounding a corporation's refusal to pursue derivative litigation when the board appears independent enough to be able to properly refuse the demand to sue. The Court carefully reviews past Delaware precedent and outlines what documents the stockholder may review.
The decision makes major points. First, the stockholder who has made a pre-suit demand does not thereby conclusively concede the board is independent and disinterested. Second, the decision to not sue is subject to the business judgment rule but that presumption may be rebutted by a showing the decision was not in good faith or was unreasonable. [Note that it is generally thought that the BJR precludes a reasonableness review but we will see if that is still true in this limited area. Most likely what the Court meant is that the decision has to be so unreasonable that no director in good faith could reach that conclusion.] Third, the Court of Chancery has, according to a federal court, exclusive jurisdiction over books and records cases under Delaware law.
This is an important decision because it shows the way much future derivative litigation must proceed. Books and records cases are fairly easy to litigate. This then permits plaintiffs to get behind the usual demand-refused letter that just states the process used and the conclusion not to sue and fails to say why. Of course, it remains to be seen if any plaintiff can make a showing after inspection to overcome a rejection of a demand to sue.
ShareCourt Of Chancery Explains Disclosure Rules For Adviser Fees
In re Atheros Communications Inc. Shareholder Litigation, C.A. 6124-VCN (March 4, 2011)
This decision outlines what must be disclosed to shareholders asked to approve a merger. As to the financial adviser giving a fairness opinion, the disclosures should include whether its fee is contingent on a closing and if so, how much of the fee is contingent. The amount of the fee should also be disclosed.
The decision also held that when the CEO learned he would be employed by the acquiror, that should have been disclosed as well.
ShareCourt Of Chancery Denies Receiver For LP
Steven M. Mizel Roth IRA v. Laurus U.S. Fund LP, C.A. 5566-VCN (February 25, 2011)
This decision has a good summary of the past decisions holding that it is rare for a receiver to be appointed for an LP. This is particularly true for an investment fund that is still in the business of investing even if the plaintiff is unhappy with the results.
ShareCourt Of Chancery Imposes Fees For Late Discovery
Mickman v. American International Processing LLC, C.A. 4368-VCP (February 23, 2011)
This decision reaffirms the settled rule that if you fail to obey a court order to provide discovery, the Court will assess fees for a motion to compel and few excuses will change that result.
ShareCourt Of Chancery Re-affirms Board's Use Of Poison Pill To Block Inadequate Tender Offer
The Court of Chancery denied an application by Air Products and Chemicals, Inc. to force the board of Airgas, Inc. to redeem its poison pill so as to allow the stockholders of Airgas to decide whether to tender into Air Products' all-cash, all-shares offer. The Court in this 153-page opinion carefully applies Delaware Supreme Court precedent in holding that the Airgas board reasonably believed that the Air Products offer was inadequate and that its decision to maintain its pill was a reasonable response to that threat. A major factor in upholding the reasonableness of the Airgas board's actions was that three directors nominated by Air Products supported the decision to maintain the pill. While some have questioned the continued vitality of doctrine that allows the board to maintain a poison pill in the circumstance of an all-cash, all-shares and fully financed offer, this decision re-affirms Delaware's director-centric approach to corporate governance. The description in the opinion of the process followed by the Airgas board serves as a primer for how a board might defend against a tender offer it believes is inadequate.
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Court Of Chancery Validates Top Up Options
Olson v. ev3, Inc., C.A. 5583-VCL (February 21, 2011)
In recent years, top up options have been frequently used to speed up a merger by avoiding the time-consuming and expensive process of soliciting proxies to approve a merger after a successful tender offer. This decision explains how such an option works and why they are permitted under Delaware law.
The decision is also important is pointing out certain perils in the way top up option rights are structured. The option needs to comply with the provisions of the DGCL governing stock options.
ShareCourt Of Chancery Permits Inspection of Pre-Ownership Events
Sanders v. Ohmite Holding LLC, C.A. 5145-VCL ( February 21, 2011)
This decision determines that an owner of an LLC interest may obtain inspection of its books and records even with respect to events that occurred before he became a member.
ShareCourt Of Chancery Explains Categories Of Damages
Agreements sometimes try to limit any damages from a misrepresentation or contract breach by excluding consequential or special damages. This decision notes that is hard to do because what falls into what category of damages is not always clear. Better to limit damages some other way such as by the amount paid to the seller.
The opinion is also noteworthy as an example of the far-reaching scholarship the Court undertook to understand the science involved in the dispute. Litigants should not underestimate the Court of Chancery in such matters.
ShareCourt Of Chancery Creates Unique Remedy
In re Del Monte Foods Company Shareholders Litigation, C.A. 6027-VCL (February 14, 2011)
This is an important decision if only for the creative remedy that the Court came up with to deal with the breach of faith by a target's investment bank. In effect, the investment bank was willing to sell out its client to get a piece of the buy-side financing. The Court enjoined the deal for 20 days to let a competing bid emerge while at the same time not killing a deal that the target's stockholders might want.
The decision gives guidance to advisers on the proper conduct they should be expected to follow.
ShareSupreme Court Upholds Fee Award In No Damage Case
William Penn Partnership v. Saliba, C.A. 362, 2010 (February 9, 2011)
In this unusual decision the Supreme Court upheld an award of attorneys fees and costs to plaintiffs who proved a breach of fiduciary duties owed to them but where there were no apparent damages from the breach. In that way the plaintiffs were compensated for the breach. It is not clear if this means that in every breach of fiduciary duty case that attorney fees may be won by the plaintiffs as well. I doubt it for the Court does not announce any such major change in Delaware law and the decision seems limited to its peculiar facts. But, you can not know for sure.
ShareSpecial Master Reports On Fee Request
Fuhlendorf v. Isilon Systems, Inc., C.A. 5772-VCN (February 8, 2011)
In this report of a well-respected Delaware attorney serving as a special master, there is much to be learned about how to seek advancement of fees. He does a good job of explaining Duthie v CorSolutions Medical Inc., 2008 WL 4173850 (Del. Ch., Sept. 10, 2008), a leading decision on the administration of advancement claims. Finally, he comes up with the procedures going forward to avoid all the bickering over fees that so dominates this area.
If you doubt this is a real problem, note that the earnings restatement that gave rise to the underlying litigation involved $4.8 million. The attorney fees for just this one defendant approached $7 million.
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