Delaware Business Litigation Report

Supreme Court Clarifies Stockholder Ratification Law

Gantler v. Stephens, C.A. 132,2008 (Del. Jan. 27, 2009)

 

This is an important decision because it limits when stockholder approval of a transaction has the effect of ratifying director action. Moreover, it limits the effect of stockholder ratification by holding that the business judgment level of review still applies to the directors' action, rather than holding that ratification extinguishes any claim.

 

The ratification holding is that stockholder ratification only occurs when the stockholders approve a transaction that the directors are empowered to take without the approval of the stockholders. For example, because directors are able to issue stock without stockholder approval, the added approval of the stockholders would ratify their decision to sell stock. In contrast, because a merger already requires stockholder approval, the approval of the stockholders does not constitute "ratification" of the directors' decision to recommend the merger. They approve it but do not "ratify" it. How is that for a distinction?

 

The rationale for this tightly reasoned result lies in the difference under Delaware law between complying with a controlling statute's requirements to carry out a transaction and having a good reason for doing the transaction in the first place. In other words, in Delaware just because you have the power to act (the stockholders voted for it) does not mean you should act (a decision that is measured by Delaware's law of fiduciary duty).

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Delaware's Top 10: The Most Important Corporate Law Decisions of 2008

    The following is a summary of the top 10 most important corporate law decisions published in 2008. The Delaware courts addressed a range of issues this past year in the areas of fiduciary duty, the negligence - bad faith continuum, advancements and mergers.

Fiduciary Duty

    The Delaware courts found occasion to reaffirm in one case and expand in two cases the reach of fiduciary duty law.

    The Court of Chancery reaffirmed that warrant holders are not owed fiduciary duties and there is no duty to keep them informed. See Corporate Prop. Assoc. 14 Inc. v. CHR Holding Corp., C.A. No. 3231-VCS, 2008 WL 963048 (Del. Ch. Apr. 10, 2008). However, the Court found further that a corporation has a duty to a warrant holder to truthfully answer its inquiries about corporate plans. When asked about a matter that implicated the warrant holders' financial interest, the corporation had a duty to answer truthfully.  More ›

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Court of Chancery Denies TRO for Laches

Topspin Partners L.P. v. Rocksolid Systems. Inc., C.A. 4275-VCL (Del. Ch. Jan. 21, 2009)

 

This decision illustrates the sometimes forgotten Delaware rule that if you get a TRO you better act fast. Here the plaintiff sat on its rights for ten months and the Court, while finding that irreparable harm might occur and that the claims appeared meritorious, denied immediate relief because of the delay.

 

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Court of Chancery Refuses To Dismiss Business Tort Case

Agilent Technologies, Inc. v. Kirkland, C.A. 3512-VCS (Del. Ch. Jan. 20,  2009)

 

This decision is interesting because it illustrates what a party to litigation can or cannot say about the case. The failure to adhere to the rules results in a business tort claim for unfair practices, etc. Here is the rule in a nutshell: You can say that there is a suit on file but you cannot say that you are sure to win and put the other side out of business. After all, that is for the Court to decide.

 

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Superior Court Holds Chancery Has Exclusive Jurisdiction To Appoint Arbitrator

Firemen's Insurance Co. v. Birch Pointe Condo. Assoc., Inc., C.A. No. 08C-04-081 JAP (Del. Super. Dec. 17, 2008).

In this decision, the Superior Court ruled sua sponte that it lacked subject matter jurisdiction over an action seeking declaratory relief and requesting the appointment of an arbitrator. The court held that under 10 Del. C. § 5704 the Court of Chancery has exclusive jurisdiction to appoint an arbitrator when the parties’ agreed upon method of appointment fails for any reason.   

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Court of Chancery Explains the Role of Merger Subs

Alliance Data Systems Corporation v. Blackstone Capital Partners V, LP, C.A. 3796-VCS (Del. Ch. Jan. 15, 2009)

 

Here the target tried to argue that the parent entity should be responsible to pay damages for its sub’s failure to close under the facts of this case. It claimed that as all the parties knew the parent had to support the sub to get the deal done, the merger agreement should be read to imply that obligation. The Court of Chancery rejected that argument as inconsistent with the terms of the merger agreement and noted that if the target knew of the risk and failed to cover that risk by securing the parent's guarantee in its agreements, then that was too bad.

 

Many mergers involve the use of a new, assetless entity that is a subsidiary of the real acquiror, as a merger partner. When the parent does not guarantee the obligations of the sub, however, the merger agreement then is really just an option for the parent to exercise or not as it sees fit. For if the sub does not close the merger, the other parties to the deal are left without a real remedy. This insulation of the parent entity is understood and intended, and is a risk the target is willing to take to get the best price.

 

 

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Court of Chancery Awards Fees in Closely Held Entity Litigation

Julian v. Eastern States Construction Company, C.A. 1892-VCP (Del. Ch. Jan. 14, 2009)

 

This decision answers the question of whether the normal rules governing attorney fee awards in derivative litigation will be applied in closely held entities. This has been a concern because some have argued that when the entity is closely held, the recovery in the derivative litigation benefits the few owners more directly and immediately than in the case of publicly held companies. For example, in subchapter S companies, the recovery is often distribution to the owners; hence, the argument goes, there is no need to award fees to give an incentive to the plaintiff to bring a derivative suit.

 

Here the Court rejected that argument and awarded fees.  After all, the amount distributed to the successful owner in such cases may not be enough to pay her attorneys and some additional incentive is appropriate.

 

The opinion is also interesting in its discussion of how to calculate those fees. Given that the recovery is fairly small, so should the fees and a multiple of hourly rates may not be warranted in such cases.

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Court of Chancery Dissolves a Deadlocked LLC

Fisk Ventures, LLC v. Segal, C.A. 3017-CC (Del. Ch. Jan. 13, 2009)

 

It has long been established that a limited partnership may be dissolved when a deadlock makes it impossible to carry on the partnership business. Here the Court of Chancery applied that same law to an LLC as the statute also provides for a judicial dissolution when it is "not reasonably practical to carry on the business" for which the entity was created.

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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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Court of Chancery Approves Opt Out Settlement

Marie Raymond Revocable Trust v. MAT Five LLC, C.A. 3843-VCL (Del. Ch. Dec. 19, 2008)

 

This decision has a good summary of the law governing certification of a class and when to approve a class settlement. Here the settlement permitted class members to opt out without the loss of any rights to pursue other related litigation. Thus, this decision distinguished the recent decision in Off v. Ross that had disapproved a settlement without opt out rights.

 

The interesting question is whether these two cases now mean that opt out classes are favored in Delaware.  We doubt it.  However, it is certainly the case that settlements with hardly any benefits to class members are receiving even greater scrutiny.

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Court of Chancery Interprets LLC Exculpation Clause

Kahn v. Portnoy, C.A. 3515-CC (Del. Ch. Dec. 12, 2008)

 

This important decision illustrates how hard it is to make an LLC agreement cover all future events. While there is a growing school of thought that advocates letting the parties make their own bed in the form of the LLC agreement, that approach fails to appreciate how hard it is to do that well. The failure to successfully do so leaves everyone unhappy, and they would have been better off had they not tried to begin with.

 

Here the parties to an LLC agreement tried to address conflict of interest situations that were sure to occur when the entity would contract with related entities owned by its directors. They did so by a clause that was supposed to limit fiduciary duties in such cases. What happened, and it happens a lot, is that the language they used did not exactly fit the circumstances they later faced. As a result, they proceeded apparently thinking that they were alright only to be followed by the Court correctly pointing out that the language they relied upon did not work as they thought. Now they face liability under fiduciary standards they cannot meet.

 

One answer is better drafting. But given the many times that seems not to have been done, perhaps it is time to give up the effort to speak to all future events. Instead, those transactions that are expected to occur should be addressed directly and specifically. If the directors want their personal company to rent to the LLC, then they should say that is okay at least if the rent is approved by an independent third party. If they do not know what type of transactions they want to enter into, then they should fall back on the extensive fiduciary law under the Delaware corporation law that will tell them how to do a deal safely.

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Court of Chancery Upholds Post Merger Arbitration

Aveta Inc. v. Bengoa, C.A. 3598-VCL (Del. Ch. Dec. 11, 2008)

 

It is now common to provide for post merger payouts and the arbitration of any disputes about those payouts. This case illustrates the problem of what happens when one party feels it does not have enough information to go into arbitration where discovery may be limited. The Court held that when the obligation to arbitrate is not conditioned on the receipt of information, arbitration will be ordered and the parties will be left to deal with the arbitrators over information exchange issues.

 

The answer is to provide clearly for adequate information exchange rights in the arbitration.

 

 

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Court of Chancery Refuses To Impose Costs on Proxy Loser

TravelCenters of America v. Brog, C.A. 3751-CC (Del. Ch. Dec. 5, 2008)

 

In this unusual case, the LLC sought to require the loser of a proxy contest to pay the costs. The LLC Agreement had a provision that imposed costs on those members who violated any of their obligations in the agreement. The LLC claimed that when the members put up unqualified candidates for office they should pay the costs of defeating them. The Court held that as the conditions to be a candidate were not obligations of the members, but "conditions," costs would not be imposed.

 

While the opinion does not say so, this may reflect a reluctance to discourage election contests by imposing costs on the loser.

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Court of Chancery Rejects Settlement

Off v. Ross, C.A. 3468-VCP (Del. Ch. Nov. 26, 2008)

The Court of Chancery rejected the proposed settlement of this derivative suit for two reasons. First, the transaction under attack in the litigation was completed after a modification favorable to stockholders before the settlement was presented for approval, the modification was considered by the board before suit was filed, and the transaction was not dependent on approval of the settlement. Thus, the Court concluded that there was no consideration for the settlement because the modification to the deal that plaintiff relied upon to justify the settlement would have happened anyway without the suit.  A benefit received by stockholders that is not caused by litigation is not valid consideration for the settlement of the litigation.

In addition, the Court was troubled by the effect of the release that was part of the settlement on related litigation in New York. Given that the stockholders received virtually nothing for the release, it was wrong to affect their rights in the litigation elsewhere that might benefit them.

 

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District Court Awards Punitive Damages Based in Part on Discovery Abuse, Denies Attorneys' Fees for Inadequate Proof

Christ v. Cormick, 2008 WL 4889127 (D. Del. Nov. 10, 2008)

In this opinion the Court sanctioned the defendant’s conduct, including discovery abuse, by awarding punitive damages. The Court first entered default judgment against the defendant after his “repeated dilatory discovery conduct and his refusal to appear for deposition.” The plaintiff sought punitive damages in addition to compensatory damages, and the Court found that the entry of default did not preclude awarding punitive damages. The failure to appear for deposition was “but one example of the kind of willful conduct that requires an award of punitive damages.” The plaintiff also sought attorneys’ fees and expenses both for the Delaware action and proceedings in South Africa. The Court, however, denied this claim, finding that an award for fees in the South African litigation was unsupported by law, and the summary information submitted for fees for the Delaware proceeding was inadequate as a matter of law because it did not allow the Court to make a thorough analysis of the time records. 

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