Posts from 2010

Supreme Court Clarifies Forum Non Conveniens Rules

Lisa, S.A. v. Mayorga,  C.A. 410, 2009  (Del.  April 20, 2010)

This decision clarifies the effect of where an action is first filed.  When the case is filed first in Delaware, a Delaware court may only dismiss it on the grounds the forum is inconvenient when the defendant can show it will be an "overwhelming hardship" to litigate it in Delaware.

On the other hand, when an action is first filed in a forum other than Delaware, the general rule is to defer to the other jurisdiction and stay or dismiss the second suit filed in Delaware.  While there are numerous exceptions to this general rule, the burden is much less to have the case dismissed.

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Court Of Chancery Upholds Stockholder Representative Standing

Coughlan v. NXP B.V. , C.A. 5110-CC (April 15, 2010)

When a payout in an M&A  deal is dependent on post closing events, somehow the former stockholders must be represented if there are to be any adjustments.  Appointment of a stockholder representative is often done for that purpose. Here the Court held that the stockholder representative may also sue to enforce the rights of a class of stockholders to such payments.

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The Court of Chancery Reaffirms the Vitality of Claims Asserting Insider Trading as a Breach of the Fiduciary Duty of Loyalty

 Pfeiffer v. Toll, C.A. 4140-VCL (March 3, 2010)

Vice Chancellor Laster recently affirmed the continuing vitality of state law “Brophy” claims for Delaware corporations injured by their fiduciaries’ insider trading.  In so ruling, the Court clarified the elements of a Brophy claim, explained why the claim is firmly grounded in the duty of loyalty applicable to Delaware fiduciaries and discussed why such claims complement and do not conflict with the federal securities law regime. Less clear and undecided by the decision are the elements of damage the corporation might recover.

The Toll Brothers decision arose in the context of a motion to dismiss a shareholder derivative complaint brought for the benefit of Toll Brothers Inc. against eight of the eleven directors of the corporation. The complaint alleged they sold significant amounts of their Toll Brothers stock during the period from December 2004 through September 2005. The complaint further alleged that they did so while in possession of material nonpublic information about Toll Brothers’ future prospects that contradicted the Company’s upbeat disclosures about its business prospects and expected growth and earnings. When the Company in December 2005 suddenly revised its public growth forecast for 2006 net income downward from 20% to 0.5%, its stock price precipitously dropped.

A federal securities lawsuit followed joining the individual defendants and alleging they made material misrepresentations and omissions of material fact in connection with projections for 2006 and 2007 that were “knowingly unreasonable” when made. The federal action also alleged insider trading in violations of Section 10(b)(5). The federal court upheld the securities claims against a motion to dismiss under the rigorous standards for pleading securities fraud and the case moved to merits discovery.

The Delaware derivative action followed in November 2008. The Delaware complaint had two counts. The first alleged breach of fiduciary duty under Brophy v. Cities Service, 70 A.2d 5 (Del. Ch. 1949) for harm caused by insider trading. The second count was a generalized claim for indemnification and contribution for harm to the Company resulting from the federal securities fraud action. The director defendants moved to dismiss both counts on various grounds including that Brophy is an outdated precedent that should be rejected.

The Court rejected all of the defendants’ arguments challenging the Brophy claim. The Court first stated the elements of claim:  “1) the corporate fiduciary possessed material, nonpublic company information; and 2) the corporate fiduciary used that information improperly by making trades because he was motivated, in whole or in part, by the substance of that information.”

The Court found that the complaint sufficiently pled a reasonable basis from which the fiduciaries’ knowledge could be inferred. The inference was based on specific allegations of the defendants’ knowledge and reliance on core metrics the Company used to measure and forecast growth and earnings, the contrast between the defendants’ public statements and the underlying trends indicated by the Company’s metrics, and the defendants’ contemporaneous massive sale of securities. The Court ruled the allegations supported a pleading stage inference that the Sellers took advantage of confidential corporate information not yet available to the public to unload significant blocks of shares before the market’s views of Toll Brother’s prospects dramatically changed. The Court contrasted this case from those cases dismissed at the pleading stage where evidence of accounting improprieties were disclosed in a subsequent restatement and senior officers and directors sold stock during the period covered by the restatement. Those cases the Court noted lacked allegations supporting an inference that the fiduciaries would have known of the particular accounting problems, in contrast to the core operational information involved in the Toll Brothers case.

The Court also addressed and rejected the assertion that Brophy was an anachronism that predated the current federal insider trading regime and should no longer be followed. Brophy involved a corporate secretary who knew of Cities Service’s planned open market purchases that would likely boost its stock price. The fiduciary bought for his personal account in advance of the corporate purchase and later sold the shares at a profit after the market price rose. Rejecting the argument that the corporation suffered no harm, the Brophy Court said “Public policy will not permit an employee occupying a position of trust and confidence toward his employer to abuse that relation to his own profit, regardless of whether his employer suffers a loss.” 

Vice Chancellor Laster in the Toll case explains why the Brophy claim does not duplicate the federal securities laws and does provide a meaningful remedy for corporate harm. First, a Brophy claim does not exist to recover losses by contemporaneous traders, nor does it automatically require disgorgement of reciprocal insider trading gains; rather it is to remedy harm to the corporation. Pointing to Delaware Supreme Court precedent rejecting claims of breach of fiduciary duty or fraud as a basis for the class-wide recovery of trading losses, the Court agreed with Vice Chancellor Strine in his recent AIG opinion upholding a Brophy claim that it is harm to the corporation that is of primary concern. Vice Chancellor Laster wrote that harm in the case of insider trading might include the costs and expense the corporation incurred for regulatory proceedings involving the insider trading, internal investigations, fees paid to counsel and other professionals, fines paid to regulators and judgments in litigation. In this case and the recent AIG case, both of which involved companion securities law litigation naming the corporation a defendant, the Court noted that the defendants’ breaches of the duty of loyalty, involving trading on confidential information and material misrepresentations and omissions, may subject the corporation to a substantial judgment or settlement in the federal securities action.

The Court left to another day the precise type of damages or remedy that would be available if plaintiff proved its case. It noted, however, that Delaware remedies to protect the corporation and non-duplicative of the federal remedies that might be granted, were necessary and available to remedy breaches of the fiduciary duty of loyalty based on insider trading.  Avoiding damages duplicative of the federal securities laws and satisfying public policy concerns regarding indemnification for securities fraud violations remain significant issues in fashioning a damage award for successful derivative plaintiffs. See e.g., Richard A. Booth, The Missing Link Between Insider Trading and Securities Fraud, 2 J. Bus. & Tech. L. 185-206 (2007).

The Court’s opinion also dealt quickly with defendants’ arguments that the derivative complaint failed to plead demand futility adequately under Rule 23.1 and was barred by the statute of limitations. Using the Rales standard, the Court concluded that demand was excused because a majority of the Board could not consider the merits of a demand without being influenced by improper considerations. Because of the potential personal liability a majority of the directors faced in the federal securities action, they faced a sufficiently substantial threat of personal liability to compromise their ability to act impartially on a demand.

As to the statute of limitations, the Court acknowledged that the complaint was filed more than 3 years after the alleged insider trading, but it found the pleading supported a basis for equitable tolling. Because the complaint alleged wrongful self-dealing and shareholders’ reasonable reliance on the competence and good faith of the director fiduciaries until December 2005 when management officially abandoned its previous growth projections, the Court ruled the running of the limitations period was equitably tolled until then.

Finally, the Court acknowledged the tension between allowing the concurrent prosecution of the shareholder derivative action for the benefit of the corporation at the same time the corporation seeks to defend itself from liability in the federal securities action. Not wanting to have the derivative action burden the corporation’s ability to defend itself in the securities action, the Court urged the parties to coordinate the actions and acknowledged the possibility of a stay of the derivative action pending the outcome of the securities action as was done in the AIG case.

 

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Supreme Court Divides Over When Fair Dealing Claim Exists

Nemec v. Shrader , C.A. 305, 2009 (April 4, 2010)

In a rare split amongst the Justices, the Delaware Supreme Court has divided over when the duty of good faith and  fair dealing applies. The majority opinion is an example of the views of  Chief Justice Steele who is noted for his stance that  a contract should be held to fix the parties' rights and there is little room to add to those rights under the so-called duty to act in good faith and with fair dealing.  If the circumstances that the plaintiff complains of might have been anticipated when the contract was drafted, it is too bad if the contract does not give the plaintiff what he now wants.

The two Justices in the minority, Justices Jacobs and Berger, are not so sure they want to rely entirely on what the parties put into their contract to define their rights in all circumstances. They are more inclined to expand a party's rights when they feel the other side has acted in a way that would not have been agreed to had they thought about it beforehand.

For now at least, the strict upholding of the contracts limits has won the day.

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Court Of Chancery Limits Remedy For Charter Breach

Fletcher International Inc. v. ION Geophysical Corp.,  C.A. 5109-VCP (March 24, 2010)

When a provision in a certificate of incorporation is violated, the question that often arises is what is the remedy. Often the Court  will enjoin the violation, but not always. Here the preferred stock had approval rights for certain corporate transactions. Those rights were violated. Finding that an injunction would cause more harm than was merited, the Court denied the injunction and remitted  a damages remedy to the plaintiff.

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Court Of Chancery Rejects SLC Report

London v Tyrrell, C.A. 3321-CC (March 11, 2010)

When should the recommendations of a SLC to not pursue a derivative suit be accepted? As this opinion points out, certainly not when the defendants appoint their relative to the SCL and those that are indebted to them. Nor will the SCL be respected when its members approach their investigation with views fixed before their investigation was performed and when their non-Delaware counsel does not understand Delaware law.

This decision summarizes the Zapata principles for examining the report of a SLC, including a good summary of prior case law.  Apart from the basic rules it sets down on burden of proof, independence and the scope of any SLC investigation [all of which alone are worth reading], the decision's analysis of the internal logic of the SLC report is critical. Put simply, the Court wants the report to make sense under an objective review and when it does not, trouble will follow.

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Court of Chancery Dumps Class Counsel

In re Revlon, Inc. Shareholders Litigation, Consol. C.A. No. 4578-VCL  (March 16, 2010)

Vice Chancellor Laster took the unusual step of removing and replacing co-lead counsel and Delaware liaison counsel in a proposed settlement of a class action challenging a proposed merger by a controlling stockholder and a subsequent exchange offer by the target company.   Despite the refusal of the Special Committee's financial advisor to render a fairness opinion on the proposed merger and the refusal of the Special Committee to recommend the original transaction, plaintiffs' counsel engaged in minimal litigation efforts and quickly reached a settlement with the defendants.  Vice Chancellor Laster was highly critical of the actions of the New York and Delaware firms representing the class and proposing the settlement.  Among other things, Vice Chancellor Laster noted the New York and Delaware law firms' extensive history of filing and settling representative cases in the Court of Chancery, the existence of significant discrepancies between the plaintiff counsel's actions as set forth in the memorandum of understanding and the exchange offer, the strong possibility of the entire fairness standard applying to the exchange offer, the failure of the exchange offer to receive a majority of the minority shares and the lack of litigation by the plaintiffs' counsel.  Although the new counsel had only sought to represent stockholders who exchanged their shares in the exchange offer, Vice Chancellor Laster appointed that counsel to represent the entire class and take over the litigation.  Interestingly, Vice Chancellor Laster rejected the leadership structure proposed by new counsel, which would have consisted of two non-Delaware firms known for performing the same type of work as former counsel as lead counsel and a Delaware firm less known for performing similar work as Delaware liaison counsel.  Instead, Vice Chancellor Laster appointed the Delaware firm to act as lead counsel along with the non-Delaware firms and gave the Delaware firm decision-making authority in the event of disagreements.

Plaintiffs' counsel and defense counsel should pay close attention to this decision in negotiating settlements, drafting disclosures related to such settlements and defending such settlements in the Court of Chancery.  This decision could also encourage law firms not traditionally associated with frequent representative litigation in the Court of Chancery to bring such actions and seek appointment as lead counsel.

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Court Of Chancery Explains Rights Of Preferred Stock

 LC Capital Master Fund, Ltd. v. James,  C.A. 5214-VCS (March 8, 2010)

 Lately, there seems to be a lot of interest in the rights of preferred stock compared to the rights of common stock and how the board of directors should act when caught in the middle of their conflicting claims. This decision summarizes the past decisions and explains what to do.

Here are some "rules" to go by:

1. When the certificate of incorporation speaks to the preferred stock's rights on an issue, that controls and the board does not need to consider granting greater rights to the preferred. The charter ends the discussion.

2. When the certificate of incorporation is silent on an issue and leaves the preferred in the same position as the common [such as on the right to get the highest price for the company in a merger] then the board needs to consider the preferred and common as having the same rights and owed the same fiduciary duty.

3. When the issue somehow falls in a gap between the preferreds rights under the certificate of incorporation and the rights of the common stock, get a good lawyer. Seriously, the board needs to do its best to strike a  fair balance under the circumstances.

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Court Of Chancery Upholds Nullification Claim

Thor Merritt Square LLC v. Bayview Malls LLC, C.A. 4480-VCP (March 5, 2010)

On occasion, the members of an LLC try to end its life by filing a certificate of cancellation with the Delaware Secretary of State. This is done in the hope that it will provide a defense to suits over the LLC's obligations. Well, that does not work. As this decision explains, a creditor may then file a claim to nullify the certificate of cancellation and to seek a receiver.

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Court Of Chancery Upholds NOL Pill

Selectica Inc. v. Versata Enterprises, Inc., C.A. 4241-VCN ( February 26, 2010) In a case with an unusual factual setting, the Court of Chancery has upheld a poison pill with a 5% trigger. The very low trigger is explained by the need to protect a NOL that might be adversely affected by the acquisition of 5% of a company's stock. In its discussion of the Unocal standard of review that applies to defensive measures, the Court applied a very differential approach to the board's decisions. Arguably, that is not the higher standard of review that had been suggested by Moran as applicable to the adoption of a poison pill. This decision illustrates the Court's limited role in reviewing board's decisions that are not affected by any conflict of interest on the part of directors. Briefly, unless there is a duty of loyalty issue involved, directors just will not be second guessed in Delaware. This decision was affirmed . See 5 A3d 586 (Del Sup.) Share

Court Of Chancery Discusses Scope Of Arbitration

RBC Capital Markets Corp. v. Thomas Weisel Partners LLC, C.A. 4709-VCN (February 25, 2010)

Many decisions discuss when arbitration is required by an agreement.  This one deals with the rarer problem of what claims may be presented to arbitrators in a matter that the parties concede must be arbitrated.  The Court will usually leave that decision to the arbitrators in the first instance, but will at least consider if a claim is so far outside  the scope of the arbitration clause that its presentation should be barred.

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Court Of Chancery Explains How To Apply For Fees

Global Link Logistics Inc. v. Olympus Growth Fund III, L.P., C.A. 4444-VCP ( February 24, 2010)

This decision explains what should be in a fee application to the Court of Chancery. Redacted bills, explanations of what the time was for and why it was spent are all required in a contested matter.

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Court Of Chancery Interprets Exculpation Clause In LLC Agreement

Kelly v. Blum, C.A. 4516-VCP (February 24, 2010)

It is well known that an LLC agreement may limit the right to sue for breaches of fiduciary duty. What is less well thought out is what language needs to be used to do so. This decision tells you what to say if you want to limit liability.

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Court Of Chancery Explains Damage Calculations In Trade Secret Litigation

Agilent Technologies Inc. v. Kirkland, C.A. 3512-VCS ( February 18, 2010)

Calculating damages in trade secret litigation is often difficult.  Lost profits may overlap with unjust enrichment claims and the whole process may be affected by possible injuntive relief. This decision explains how a court will decide the right remedy and calculate damages.  It is also a particularly good example of the Court of Chancery's thoughtful approach to remedies.

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Court Of Chancery Denies Power To Eliminate Board Seats

Kurz v. Holbrook, C.A. 5019-VCL  (February 9, 2010)

This significant decision holds that you cannot eliminate a director by amending the bylaws to reduce the number of seats on the board of directors.  Of course, this only came up in the odd context of a stockholder who could not vote for directors and hence could not vote to eliminate them as well. Nonetheless, it is interesting as a limit on the power to amend bylaws

Perhaps more importantly, the decision explains the complicated and often misunderstood ways in which proxies are obtained to vote the shares of public companies. Those shares are mostly held in the name of Cede & Co., a depository for brokers and banks.  Getting the proxy from Cede, and then to the brokers and then to the actual beneficial owners has proved cumbersome in fast proxy battles. This decision helps that process by letting the records of Cede act as a list of owners.

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