Delaware Business Litigation Report

Superior Court: A Secured Loan Transaction Only Conveys A Security Interest, Not Legal Title

Segovia v. Equities First Holdings, LLC, 2008 WL 2251218 (Del. Super. Ct. May 30, 2008).

This decision offers predictability to parties entering into straightforward secured loan transactions under Delaware law. It assures that a security interest will not be treated as a conveyance of legal title. And, it prescribes that if a party intends for a transaction to result in the conveyance of rights to the secured lender greater than a security interest, then that party must set forth crystal clear and unequivocal language in the parties’ contract.  More ›

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Court of Chancery Issues Major Disclosure Law Decision

In re Transkaryotic Therapies, Inc., C.A. 2776-CC (Del Ch. June 19, 2008)

The law of Delaware on when damages may be awarded for failing to make proper disclosures to stockholders in a proxy statement has been unsettled. This major decision resolves much of that uncertainty. The Court has now held:

“. . . this Court cannot grant monetary or injunctive relief for disclosure violations in connection with a proxy solicitation in favor of a merger three years after that merger has been consummated and where there is no evidence of a breach of the duty of loyalty or good faith by the directors who authorized the disclosures.”

The opinion carefully reviews and harmonizes precedent to reach this final conclusion. The net effect then is that the remedy for negligent disclosure violations is an injunction. Of course, as the opinion makes clear, damages may still be available in circumstances where there was a conflict of interest by the directors or they acted in bad faith. The latter would occur, for example, if the directors omitted substantial materials from the proxy statement deliberately to mislead.

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Court of Chancery Explains Distribution Rights Issues

Schuss v. Penfield Partners LLP, C.A. 3132-VCP (Del. Ch. June 13, 2008)

This decision explains how distribution rights for a withdrawing partner may be determined and points out that ambiguous language in the partnership agreement may lead to uncertainty. This was particularly important here as the withdrawing partner was given an in-kind distribution of these hedge funds securities after they had declined in value in the period after the date for determining the partner's share and the actual distribution date. This may become an important issue when the market is declining.

The Court also held that the plaintiff had stated a claim for breach of fiduciary duty by alleging the controlling general partner had selected the assets to go to the departing partner with the intent of hurting his interest.

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Court of Chancery Criticizes Form Bylaws

Gary v. Beazer Homes USA, Inc., C.A. 3537-VCS (Del. Ch. June 11, 2008)

Form bylaws taken from treatises or filings with the SEC are often copied without much thought. In this decision, the Court of Chancery warns that a very common set of those bylaws does not properly set out advancement rights for attorney fees. Hence, using that form without modification is now a sure way to lose those rights.  Check out the form involved in this case and be sure to change it to more accurately reflect what is intended as to advancement.

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Court of Chancery Explains How To Defend In A Deadlock

Maitland v. International Registries, LLC, C.A. 3669-CC (Del. Ch. June 6, 2008)

It often occurs in a dispute between the owners of a closely held corporation or LLC that no one has enough votes to decide who should be counsel to the entity in the litigation. This decision explains how to deal with that problem. The answer is for the owner or group of owners who are not the plaintiff to intervene in the litigation to act on behalf of the entity. This avoids the tough issue of who pays the attorneys’ fees for the entity as the intervener pays her own counsel.

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District Court Denies Motion to Dismiss, Allows Duty of Care, Loyalty and Fraud Claims to Proceed

Ad Hoc Comm. of Equity Holders of Tectonic Network, Inc. v. Wolford, 2008 WL 212 7464 (D. Del. May 21, 2008)

The District Court recently allowed claims for breach of the duties of care and loyalty against former directors and officers of Tectonic Network, Inc. (the “Company”) to go forward, rejecting Defendants’ jurisdiction, standing and insufficient claim arguments. Plaintiff, an Ad Hoc Committee of Equity Holders in the Company, sued Defendants for purportedly improper conduct in connection with the acquisition of three businesses and the resulting sale of one of the Company’s subsidiaries. Plaintiff alleged that Defendant Officers (Officer #1 and Officer #2) committed fraud related to the Company’s actions, and all Defendants breached their fiduciary duties. Specifically, Plaintiff alleged that the Defendants breached their fiduciary duties in recommending and/or approving the acquisition of the three businesses, all of which Officer #1 had a majority interest in. Plaintiff also alleged that the Defendant Officers committed fraud in making material misrepresentations to the board regarding the profitability of the acquired businesses and the prospective profitability of a future business plan that resulted in the sale of the Company’s subsidiary. Subsequent to acquisitions and sales, the Company’s financial picture worsened, and it filed for voluntary Chapter 11 bankruptcy. The Bankruptcy Court lifted the stay to allow Plaintiff to press its claims outside of the bankruptcy proceedings. More ›

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Court of Chancery Defines Unreasonable

Venhill Limited Partnership v. Hillman, C.A. 1866-VCS (Del. Ch. June 3, 2008)

For a director of a Delaware corporation to be guilty of gross negligence, her conduct must be so unreasonable that no one could have made the same decision. Unless the decision under review is this bad, it will be protected by the business judgment rule. This gross negligence rarely happens and it is thus difficult to find decisions that illustrate the type of conduct that meets this test. In fact, in this decision the defendant had a conflict of interest and thus the business judgment rule did not apply for that reason.

However, the Court went to great length to point out that the investment decisions under review did also exceed the gross negligence standard. This explanation provides an insight into what sort of decision-making is a breach of fiduciary duty. For example, in this case the investment was in a company that did not have a business plan, was continuously losing money, and was generally in such poor shape that no one but the hapless defendant would have lent it money. In short, it was gross negligence to make the loans and the defendant was liable for them as a result.

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Court of Chancery Explains Quasi Appraisal Remedy

Berger v. Pubco Corp., C.A. 3414-CC (Del. Ch. May 30, 2008)

More often than we may expect, Delaware corporations commit errors in notifying stockholders of their right to an appraisal after a merger. For some reason, on several occasions the wrong version of the appraisal statute was sent to the stockholders, violating the statutory requirement that a current version accompany the notice of appraisal rights. More commonly there is a disclosure problem, often a failure to provide enough information to permit the stockholders to decide if they should seek appraisal rights. This case involves both using the wrong version of the statute and failing to tell the stockholders of a closely held company how the merger price was set. Both those errors called for the Court to grant quasi appraisal rights.

The decision is particularly interesting for its explanation of how quasi appraisal proceedings should work. Basically, it involves starting all over again by sending out a corrected notice with the right statute attached and giving stockholders another chance to seek appraisal. Note that this is more favorable to the company than simply holding that the case may proceed as a class action for all minority stockholders.

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Court of Chancery Upholds Advancement Bylaw

Underbrink v. Warrior Energy Services Corporation, C.A. 2982-VCP (Del. Ch. May 30, 2008)

When a board is about to be sued, it is a good idea to review the bylaws to see if they provide the right to have your attorney fees advanced by the corporation. Here the claim was that the board's decision to amend the bylaws to cover advancement rights was an interested transaction that was subject to the intrinsic fairness rule. Prior case law had applied that rule when the litigation was actually pending and a board acted to confer advancement rights as a result. The Court ruled that the decision to confer advancement rights for any future litigation was protected by the business judgment rule. Hence, the fact that the litigation had not yet been brought was important.

It is possible to overstate the holding of this case as it involved an odd set of facts. If the filing of suit against the directors was virtually assured, the decision might have been different. Some caution is required before deciding that the rule of this case applies to all pre-litigation decisions on advancement.

 

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Special Committee Releases Report on Delaware Superior Court Toxic Tort Litigation

A Special Committee appointed by the Delaware Superior Court has released its report and recommendations on Superior Court toxic tort litigation. The report (copy available here) followed the Special Committee’s investigation into concerns expressed by the Delaware State Chamber of Commerce that an increasingly large number of asbestos cases was adversely impacting the ability of the Delaware Superior Court to effectively and fairly adjudicate civil cases.

The Special Committee

• solicited input from all the parties involved in toxic tort litigation in Delaware
• held a public hearing where numerous persons spoke (including practicing attorneys, law professors and Chamber representatives) and
• met separately with representative groups of defendants’ and plaintiffs’ counsel. 

Almost entirely, the focus of all these groups was on asbestos litigation.  After studying all this information for over five months, the Committee concluded “that the Delaware asbestos litigation is fairly conducted for both defendants and plaintiffs and is effectively resolving claims ... very well.”

The Special Committee particularly noted the willingness of the Superior Court judges to meet with the litigants’ counsel to structure unique procedures that fit their needs in this high-volume litigation. Recently, those procedures were amended to address concerns over plaintiffs’ disclosures and other matters. Hence, the Special Committee recommended that the parties to Delaware's asbestos litigation continue to address amongst themselves how to solve any remaining concerns over how that litigation is conducted.

While it is too early to know if the Special Committee’s report will be fully accepted by all concerned, initial reactions have been positive. In particular, the willingness of the Delaware courts to address litigants’ concerns in a positive manner has served to further support Delaware’s reputation for a fair court system. 

Edward M. McNally, a Partner and Chair of the Litigation Practice of Morris James LLP, was a member of the Special Committee.  If you have specific questions about the report, he can be contacted here.

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Court of Chancery Determines Complex Indemnification Claim

Zaman v. Amedeo Holdings Inc., C.A. 3115-VCS (Del. Ch. May 23, 2008)

Determining when indemnification rights apply is sometimes tough to do. The claims for which indemnification are sought are often drafted so as to avoid alleging that the defendant is being sued for something he did as an officer or director, but instead allege that he acted in a personal or agency relationship such as a lawyer. In this case, the Court of Chancery offers an insight into how that Court will parse through this problem. Put simply (and perhaps too simply), if there is a doubt as to the basis for the claim, the person seeking indemnification will prevail. This is as it should be given the importance of preserving the right of indemnification.

This opinion also has some interesting insights into how to apply the Roven analysis that permits a defendant to counterclaim and still obtain indemnification for the fees incurred for acting offensively.

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Superior Court Alters ADR Rules, Substitutes Mediation as Default Format

Effective March 1, 2008, the Superior Court amended Civil Rule 16 and repealed Civil Rule 16.1 to alter the compulsory alternative dispute resolution ("ADR") process mandated under Court rules.  The amendments substitute mediation for arbitration as the Court's default format for ADR in the event the parties cannot agree.  The amendments also require parties to make a good faith effort to agree on an ADR Practitioner, or face possible Court-imposed sanctions.

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District Court Dismisses Declaratory Relief, Contract Claim for Lack of Personal Jurisdiction

Solae, LLC v. Hershey Canada Inc., 2008 WL 2011914 (D. Del. May 9, 2008)

Solae LLC (“Solae”), a Delaware LLC with a principal place of business in Missouri, brought a declaratory relief and breach of contract action in Delaware District Court against Hershey Canada, Inc. (“Hershey Canada”), a Canadian corporation with its principal place of business in Ontario. The claims arose out of a contract for Solea’s provision of soy lecithin to Hershey Canada’s Ontario facility. A shipment of the product contained salmonella, prompting a recall of Hershey Canada’s product in Canada and a Canadian government investigation. Hershey Canada informed Solae that it was liable for any ensuing damages from the recall and investigation, and also refused to accept or pay for additional deliveries of the product under the contract. Solae thereafter initiated this declaratory relief and breach action, and Hershey Canada sought dismissal, among other things, on lack of personal jurisdiction grounds.  More ›

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Court of Chancery Upholds LLC Agreement Voting Rights

Fisk Ventuers LLC v. Segal, C.A. 3017-CC (Del. Ch. May 7, 2008)

A Delaware LLC is a creature of the members' contract. Here the LLC agreement gave voting rights to a class of members that effectively gave them veto rights over certain actions. When those members exercised those veto rights, the other members sued claiming that constituted a breach of duty. The Chancellor flatly rejected that argument as an attack on the veto rights that were given in the LLC Agreement.

The opinion also holds that a member's consultation with his designated managers on the LLC Board does not give Delaware jurisdiction over that member under the long arm statute's provisions that subject managers to jurisdiction in Delaware.

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Court of Chancery Again Rejects a One Person Special Litigation Committee

Sutherland v. Sutherland, C.A. 2399-VCL (Del. Ch. May 5, 2008)

Once again, the Court of Chancery has shot down a motion to dismiss a derivative suit based on the work of a one person SLC. This time while finding the SLC was independent, the Court felt its work was not adequate because of a lack of effort in reviewing accounting records.

The opinion is a useful collection of SLC law, particularly what not to do if you are going to use a SLC.

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