Delaware Business Litigation Report

Court of Chancery Denies Jurisdiction Over Stock Appreciation Rights Suit

Testa v. Nixon Uniform Service, Inc., C.A.3886-VCS (Del. Ch. Nov. 21, 2008)

In a novel attempt to invoke the jurisdiction of the Court of Chancery, the plaintiff tried to rely upon Section 111(a)(2) of the Delaware General Corporation Law that provides the Court of Chancery jurisdiction in disputes over stock. Here the plaintiff was really seeking money damages for the failure to be paid the full value of his SARs. The court held this was a claim for money damages that it did not have jurisdiction to decide, not a claim over ownership of stock.

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Court of Chancery Clarifies Statutory Trust Law

Cargill, Incorporated v. JWH Special Circumstance LLC, C.A. 3234-VCP (Del. Ch. Nov. 7, 2008)

 

In this major opinion, the Court of Chancery held that a manager of a Delaware Statutory Trust has a fiduciary duty to the Trust absent a clear exclusion of that duty in the trust instrument. This conclusion has broad implications including that the owners of the manager may also have such duties in connection with transactions that arguably benefit the owner. That is consistent with a long line of Delaware case law in other contexts, such as for corporations and limited partnerships.

 

This once again illustrates the need for very careful drafting in these alternative entities where the governing instrument may set the rules of the game. Failure to do so means that principles of corporate law, or in this case, trust law, will control by default. That will defeat the whole purpose of using an alternative to the traditional corporate form to gain the right to draft rules for that particular transaction.

 

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Court of Chancery Denies Stay in Merrill Lynch Case

County of York Employees Retirement Plan v. Merrill Lynch & Co., Inc., C.A. 4066-VCN (Del. Ch. Oct. 28, 2008)

 

In this decision, the Court of Chancery again affirms it disinclination to stay proceedings in Delaware just because a federal securities case was filed first elsewhere. Some doubt about that issue may have existed after the Court did stay a Delaware case involving Bear Sterns in favor of federal litigation in New York. But as this opinion notes, the Bear Sterns case was unique.

 

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Court of Chancery Applies Statute of Frauds to LLC Agreement

Brian T. Olson v. O. Andreas Halvrosen, C.A. 1884-VCL (Del Ch. Oct. 22, 2008)

 

This decision invalidates a provision in an unsigned LLC agreement for violating the statute of frauds. The Delaware LLC Act permits an oral LLC agreement; however, when the promise in that oral agreement cannot be performed within a year, the promise must be in writing. Given the common existence of oral LLC agreements, this decision sounds a word of caution.

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The Delaware "Bad Faith" Dilemma: The Problem And A Possible Solution

Introduction
A recent Delaware Court of Chancery decision has generated much discussion over whether disinterested directors may be held liable for approving a transaction that appeared reasonable to them and their advisors. Indeed, by holding that the directors may have acted in “bad faith,” the decision seemed to some to be a threat to the core principles embodied in the business judgment rule. That rule protects directors from being second guessed by courts long after the business decision has been made. These concerns are overstated. This article will: (1) outline the background to the current controversy over “bad faith” in Delaware, (2) predict how the Delaware Supreme Court will clarify the Delaware law of “bad faith” and (3) suggest a possible solution to address lingering concerns over director liability for disinterested business decisions.

The “Problem”
For many years Delaware limited director liability for disinterested business decisions to those decisions properly held to be grossly negligent. This high standard seemed adequate to protect directors from inappropriate judicial second guessing. Then in 1985, Smith v. Van Gorkom held a board was grossly negligent. Many commentators felt Van Gorkom demonstrated the inability of courts to understand what should constitute gross negligence. The Delaware Legislature promptly responded to Van Gorkom by adopting Section 102(b)(7) of the Delaware General Corporation law. That new statute permitted Delaware corporations to include a provision in their certificate of incorporation that immunized directors for even grossly negligent decisions. Section 102(b)(7) has its exceptions, however. One of those is that actions “not in good faith” lose the statutory protection from liability.

As might be expected, if directors could not be successfully sued for actions “in good faith,” it was only a matter of time before plaintiffs filed claims alleging directors had acted in “bad faith”.

Bad Faith
Bad faith remained largely undefined until 2005. After much debate regarding whether good faith was an independent fiduciary duty and what exactly constitutes good (and bad) faith, Chancellor Chandler defined bad faith as an “intentional dereliction of duty, a conscious disregard for one’s responsibilities” and a “[d]eliberate indifference and inaction in the face of a duty to act.” The Delaware Supreme Court then set out three different categories of fiduciary behavior that might deserve the “bad faith pejorative label.” The first, fiduciary conduct motivated by an intent to do harm, was aptly labeled “subjective bad faith” The second category involves “fiduciary action taken solely by reason of gross negligence and without any malevolent intent,” a lack of due care. The court decided, however, that gross negligence without more does not constitute bad faith, and thus does not breach the duty of loyalty. The third category is the Chancellor’s definition of bad faith, as intentional dereliction of duty, a conscious disregard for one’s responsibilities. In Stone v. Ritter, the court further stated bad faith is a “fail[ure] to act in the face of a known duty to act, thereby demonstrating a conscious disregard for [one’s] responsibilities,” and thus not exculpated under § 102(b)(7). More ›

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District Court Finds Indemnity Provision Repugnant to Delaware Public Policy, Refuses to Enforce

Kempski v. Toll Bros., Inc., 2008 WL 4642633 (D. Del. Oct. 21, 2008)

In this opinion, the District Court reinforced Delaware’s law that indemnity provisions that require one party to indemnify another party for the second party’s own negligence are void as against Delaware’s public policy. Here the Defendant, Toll Brothers, Inc., contracted with Delaware Heating and Air Conditioning Services, Inc. (“DHAC”), to perform HVAC work on Defendant’s housing developments. One of DHAC’s employees was injured while performing the work, and sued Defendant. Defendant sought indemnification from DHAC pursuant to their contract. Both Defendant and DHAC sought summary judgment on the indemnification claim. The Court found that under Delaware law, the contractual indemnification provision that Defendant sought to invoke was against Delaware public policy, and granted summary judgment for DHAC. More ›

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Court of Chancery Affirms Limitations Period for Dissolved Entity

In the Matter of Dow Chemical International Inc. of Delaware, C.A. 3972-CC (Del. Ch. Oct. 14, 2008)

This decision has a good outline of when the right to sue a Delaware corporation expires after it is dissolved. The basic rule is that after three years no suit may be filed. Exceptions may exist for entities that still have undistributed assets and when a receiver is appointed for those entities.

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Court of Chancery Upholds Merger Agreement

Hexion Specialty Chemicals Inc. v Huntsman Corp., C.A. 3841-VCL (Del. Ch. Sept. 29, 2008)

This ninety-one page opinion is must reading on how to interpret a merger agreement and on the parameters of the obligation to proceed in good faith to close a deal. In upholding the obligation to at least try to obtain the financing to close, the Court goes into great detail on why the party seeking to escape its obligations bears a heavy burden to explain actions it has taken that may impede its ability to get financing or otherwise close a deal that it no longer finds attractive.

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Court of Chancery Denies Application for Receiver

Weir v. JMACK Inc., C.A. 3263-CC (Del. Ch. Sept. 23, 2008)

This decision repeats the settled Delaware law that the Court of Chancery will not appoint a receiver for a solvent Delaware corporation absent extraordinary circumstances. Of course, having a court tell the world that your tax evasion is not "extraordinary" justification for a receiver may have been punishment enough.

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Court of Chancery Refuses Dissolution of LLC

In re Seneca Investment LLC, C.A. 3624-CC (Del. Ch. Sept. 23, 2008)

This decision applies the corporate law rule that the Court of Chancery will not dissolve a solvent entity except for extraordinary reasons. Merely acting as a holding company without an active business is not even close to good enough to warrant dissolution.

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Superior Court Employs Objective Contract Principles, Grants SJ To Builder

Capano Homes, Inc. v. Syed, 2008 WL 4182039 (Del. Super. Ct. Sept. 8, 2008).

This decision implements the objective theory of contracts adopted by the Delaware courts.  The dispute involved a homebuyer who refused to proceed to settlement, claiming that the builder breached their written agreement and that the buyer should therefore be excused from performing.  The homebuyer alleged that the completed home did not meet the parties’ agreed upon specifications for the dimensions of the garage and type of veneer.  The court granted summary judgment to the builder.    More ›

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Court of Chancery Breaks New Ground with Remedy

In re Loral Space and Communications Consolidated Litigation, C.A. 2808-VCS (September 19, 2008).

This decision covers the now familiar ground of a review of an interested transaction with a controlling parent company that is blessed by a dysfunctional special committee.  After finding the transaction was not fairly negotiated, and not substantively fair as well, the Court has granted an unusual remedy. Rather than awarding money damages, the Court has ordered the deal be restructured to make it fair, by converting the preferred stock issued to the parent to non-voting common stock.

The opinion is also particularly interesting for its discussion of the role of the special committee used in this transaction. The committee apparently felt its role was to get the best terms in the deal proposed by the parent company to make it "fair," rather than to question whether the deal was in their company's best interest. The committee's assumption that they could not just say no was in error.

The decision also touches on the rights of bondholders when a major bondholder has its consent to redemption effectively purchased. The Court noted that it is not unusual for indenture covenants to preclude that vote buying, and the absence of such a prohibition here was fatal to the complaining bondholders.

[UPDATE: The Delaware Supreme Court affirms this decision on July 23, 2009.]

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Superior Court Addresses Allocation Of Defense Costs Across Multiple Towers

HLTH Corp. v. Agricultural Excess and Surplus Ins. Co., 2008 WL 3413327 (Del. Super. Ct. July 31, 2008).

When one company acquires several other companies, which carry their own D&O liability coverage, the resulting entity then holds multiple towers of coverage.   

 

Here, the company held multiple towers of coverage and sought reimbursement for the defense costs it was advancing to certain of its officers and directors who were prosecuted in a criminal case. The issue that arose on summary judgment was whether the court had to allocate the defense costs across the multiple towers, while the criminal case was ongoing.  

 

Since none of the contracts required such an allocation, the court held that the insured company could elect to collect payments in advance from any tower and that the court would not mandate allocation at this stage. The court left open the possibility that allocation could be required at a future time, presumably upon final disposition of the case.   

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Superior Court Denies SJ, Leaves For Jury Whether Agent Had Authority

Jack J. Morris Assoc. v. Mispillion Street Partners, LLC, 2008 WL 3906755 (Del. Super. Ct. Aug. 26, 2008). 

This decision briefly reviews the three types of authority by which an agent may bind a principal: actual authority, implied authority, and apparent authority.  The principal was a limited liability company, which failed to pay the vendor it purportedly engaged to perform marketing services. 

 

The issue that arose on summary judgment was whether the purported agent, who was removed as the general manager of the LLC two days before signing on behalf of the entity, had authority to bind the entity. The court denied the vendor’s motion for summary judgment, holding that it was up to a jury to determine that question based on the factual circumstances.

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Court of Chancery Establishes Procedures for Contested Advancement Claims

Duthie v. CorSolutions Medical, Inc., C.A. 3048-VCN (Del. Ch. Sept. 10, 2008)

When advancement is sought, the amounts are often objected to as too large. While the Court of Chancery in the past has not wanted to monitor fees in such cases (leaving the amounts to be finally determined at the indemnification stage), here the Court agreed to appoint a special master to review the advancement requests. It remains to be seen whether the Court will regret this step because the Delaware Supreme Court requires a master's decision to be reviewed de novo by the Court of Chancery.
 

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