Posts from 2011

Court of Chancery Applies Delaware Law To German Investment

QVT Fund LP v. Eurohypo Capital Funding LLC I,   C.A. 5881-VCP (July 8, 2011)

When will Delaware law apply to a dispute is often not an easy question to resolve.  That is true even when the parties had agreed to sue under Delaware law but the issue presented may involve foreign law as well.  Here the Court sorted through a complicated deal involving the internal affairs of a German bank and held that some of the issues might be governed by German law but the main dispute was subject to Delaware law. This analysis is thus a useful guide in other complicated choice of law situations.

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Unliquidated Derivative Claims Continue to Have Little Value

This article was original published in The Delaware Business Court Insider | 2011-07-06

On May 31, Vice Chancellor Leo E. Strine Jr. issued an opinion denying a motion for preliminary injunction to halt a merger between Massey Energy Company and an affiliate of Alpha Natural Resources Inc. One of the critical issues in the opinion was the value of the derivative claims Massey had against certain current and former directors and officers arising out of Massey's compliance with federal mining safety regulations.

Massey's attitude toward federal mining safety regulations arguably manifested itself in the Upper Big Branch mine disaster, which resulted in the loss of 29 lives. In his opinion, Strine found that the plaintiffs had probably stated a Caremark claim against the directors of Massey and criticized the board of Massey for failing to assess the value of the derivative claims but ultimately refused to enjoin the merger, concluding that the derivative claims did not have the value plaintiffs believed.

While this result has received some negative commentary, is it really a surprise? In fact, the court's analysis is consistent with prior analyses addressing the value of derivative claims in the context of a merger. The fact that the party here is more infamous than many others did not change the analysis under Delaware law.

The plaintiffs valued the derivative claims based on the "aggregate negative financial effect on Massey that the Upper Big Branch Disaster and its Fall-Out has caused." According to the plaintiffs' expert, these damages range from at least $900 million to $1.4 billion. The court, however, rejected this theory, in large part because the computation of the value of the derivative claims was far more complicated than the plaintiffs' theory.

First, even though the plaintiffs had stated a viable Caremark claim against the directors, because of the business judgment rule and the exculpatory provisions in Massey's certificate of incorporation, in order to obtain a monetary judgment against the directors, they would have to prove that the directors acted with scienter — a difficult standard to meet, particularly with independent directors.

Second, the court also found that even as to the autocratic former leader of Massey, Don Blankenship, who was arguably responsible for Massey's approach to mining safety, meeting this standard would be difficult. The court noted that there is a large gap between pushing the limits of federal regulations while accepting minimal loss of life and knowingly endangering the mine itself by putting its very operations at risk. Moreover, Blankenship was not directly in charge of any specific mine, and tying his policies directly to any disaster would be challenging.

Third, proving that the directors acted with scienter may entitle the corporation to a monetary judgment from the directors, but it would simultaneously expose the company to third-party civil liability and potential criminal liability, and potentially deprive the directors of the ability to rely on insurance coverage, all of which would harm the company.

Fourth, after the merger, Alpha will continue to have to address direct claims against Massey from its lost and injured miners, regulatory consequences of the company's mining safety approach, and other elements of the "Disaster Fall-Out." To the extent possible, Alpha will have every incentive to shift that liability to the former directors.

Fifth, it is impossible to determine the potential derivative liability of the directors until Massey's direct liability is determined. Indeed, it is not even in the interest of Massey's stockholders to press their claims of derivative liability now, before third-party civil and criminal adjudication, lest the plaintiffs expose the company to additional liability.

Sixth, the plaintiffs' expert put no value on the ability of the company or its stockholders to collect on a potential $1 billion judgment. The company's insurance policy, even assuming it is available to cover claims against the former directors, is only $95 million. While this is no small amount, it is, as the court put it, "not material in the context of an $8.5 billion merger."

While the vice chancellor was quick to note that the Massey board's approach to valuation of the derivative claims was less than ideal, because of the factors noted above, he found that the plaintiffs had not persuaded him that the merger was unfairly priced because of the failure to value separately the derivative claims. Was this conclusion so unprecedented, however, to justify criticism of the valuation?

Delaware courts previously have been asked to consider the value of unliquidated, contingent claims belonging to the company in the valuation context. These courts have never valued derivative claims at the full value of all potential damages, but instead have considered many of the factors Strine addressed in Massey.

For instance, in Onti Inc. v. Integra Bank Inc., petitioners in an appraisal action argued that their derivative claims should have been valued as an asset of the company in the appraisal proceeding. The stockholders' expert valued the claims at more than $19 million, while the company's expert valued the claims at negative $2.5 million. The court determined that the claims had no value. In reaching that conclusion, the court adopted the theory advanced by the company's expert, that all litigation factors should be considered, including the likelihood of success on the merits, the attorney fees necessary to obtain that result and any indemnification that the company would owe to its directors. Citing to prior precedent, the court noted that "there would be strong logic in including the net settlement value of such claims as an asset of the corporation for appraisal purposes."

Later that same year, the court took a similar approach in Bomarko Inc. v. International Telecharge Inc. The court valued the claim in that case by multiplying the probability of success by the likely amount of recovery while subtracting costs incurred to obtain that result.

More recently, in Arkansas Teacher Retirement System v. Caiafa, the Court of Chancery overruled an objection to a settlement that released claims that the board failed to ascribe any value to federal derivative claims in a merger. After noting that there is no case law supporting the proposition that the board was required to undertake a separate and discrete valuation of the derivative claims pending at the time of the challenged merger, the court reached the same result as Strine did in Massey, albeit with less analysis. That is, the court noted that the claims asserted in the federal action were difficult to win, and even those that had a higher probability of success could not have the $2 billion value the objectors claimed they did. On appeal, the Delaware Supreme Court affirmed the Court of Chancery's decision to overrule the objection for the reasons set forth in the Court of Chancery's opinion.

Given these precedents, is the result in Massey all that surprising? While some contingent claims have been given value, it is the exception, and not the rule, to assign material value to contingent derivative claims. Moreover, in the context of a merger worth billions of dollars, the likelihood is low that derivative claims have material value, particularly when reasonable defenses can be interposed.

But does this decision mean that boards can just eschew any analysis of the value of a derivative claim in the context of a merger? Probably not. The Court of Chancery certainly did not condone the practice, and had the court not been persuaded that the board otherwise acted properly, the failure to do so could have had more importance.

Further, because the exception to the derivative standing rule that entering into a merger for the purpose of extinguishing derivative claims remains viable, particularly in light of the Supreme Court's opinion in Caiafa, failure to value the claims could support the conclusion that a merger was negotiated simply to avoid liability. Finally, not all derivative claims are equal in this context. As Strine noted in Massey, if Massey had a liquidated claim against a former fiduciary reduced to a judgment but failed to get any value for this claim, he could see the substantial unfairness in failing to obtain value for that claim in a merger. Alternatively, if recovery on any derivative claim after a cash-out merger would inure solely to the benefit of the acquirer, then perhaps there would be value to the buyer in obtaining that claim.

Put simply, as with many issues of fiduciary law, the context of the situation is important. What is fairly clear, however, is that unliquidated contingent derivative claims are not ascribed much value, if any, in a merger context, unless a party can demonstrate a reasonable likelihood that the net value of the claim to the company is material.

Peter B. Ladig (pladig@morrisjames.com) is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group. He represents both stockholders and directors in corporate litigation. The majority of his practice is in the Delaware Court of Chancery, although he has extensive experience in the other state and federal courts in Delaware and has been involved in over 50 published decisions. The views expressed herein are his alone and do not necessarily reflect the firm or any of the firm's clients.
 

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Will Delaware Survive Without A William In Charge?

This article was originally published in the Delaware Business Court Insider | June 29, 2011

There is trouble in Delaware.  For over 40 years the esteemed Delaware Court of Chancery has been almost always headed by a Chancellor named “William.”  From William Duffy, to William Marvel to William Quillen to William Allen and last in the line, William Chandler, the Court has been well served by its Williams.  Now that Leo Strine is about to become the rare Chancellor not named William, concern abounds over his name.  Of course, a past great Chancellor was named Grover, as in Grover Brown, but that was the exception that proves the rule.  Apart from their common name, what made all these Williams special?  That answer can be seen in looking at the characteristics of the last William, Chancellor Chandler who has just retired.

First of all, William Chandler was an honest man in an age when intellectual honesty is not common.  By honesty, of course, I do not refer to financial integrity.  All Delaware judges have had that in recent memory.  Instead, honesty means following binding precedent even when you think it is wrong.  Here, Chancellor Chandler always said what he thought and never hid his reasoning, but followed precedent even if he disagreed with the Delaware Supreme Court.

A great judge has intelligence.  The scholarship of so many Chandler opinions is astonishing for a busy judge.  Just look at the hundreds of footnotes in his recent Air Products decision issued soon after the last hearing and you must wonder how did he find the time.  Intellectual ability made the difference.  Past Chancellors such as William Allen have lasting reputations for their scholarship.  So too will this Chancellor Chandler.

A great judge has energy.  Being a judge requires paying attention to witnesses and lawyers droning on and on and then writing an opinion that decides a complicated case.  That takes stamina.  Chancellor Chandler’s frequent jogging kept him in shape and that was reflected in the energy he brought to the job.

A great judge is a good administrator.  The Court of Chancery under this Chancellor was free from internal squabbling, had a hard working staff of reporters and administrators and consistently provided great service.  While that is a tribute to that staff, it also reflects well on the person in charge – the Chancellor.  This aspect of the job is often overlooked because it is not done in public or with great fanfare.  Yet, it is vital to an effective court.  Moreover, Chancellor Chandler has a great interest in technology.  That has led the Court to be up-to-date not just with electronic fillings but with other innovations such as easy rapid transcription of hearings. 

A great judge has patience.  Chancellor Chandler is among the most patient of human beings.  He was patient with wandering lawyers, pro se litigants, impossible deadlines and constant demands on his time with rarely a complaint.  This characteristic is much more appreciated than some judges might think.  Chancellor Duffy was a small man in stature, but had total command of the Courtroom through his calm, patient demeanor.  Not for him was the sarcastic remark to put down the wrongheaded lawyer.  Chancellor Duffy instead would gently show the errors of that lawyer’s position by his patient explanations.  That is not easy and is often not acknowledged, but is important.  Chancellor Chandler had a similar quiet but effective command of his courtroom.

A great judge is a good listener.  This is more than just being patient.  It is the knack of making the person talking to you feel that you are hearing and considering every word they say.  Chancellor Chandler was the best listener I have ever seen.  He made you feel that you were the only one in the room.  On occasion at some Bar or judicial event, the Chancellor would need to participate in a conference call.  When he did, the telephone literally seemed to be part of his anatomy and even if a streaker ran by he would not blink so intent was his concentration.

A great judge is a faithful public servant.  The Court of Chancery did not need to volunteer to hold mediations and now arbitrations of business disputes in addition to its regular, full docket.  But to keep Delaware as a leader in resolving business disputes, this Chancellor was an early advocate of these additional services to business litigants.  That is a burden that he and the Court took on and that is all done in private without any public appreciation for that extra effort.  That is real public service.

Finally, a great judge enjoys his job.  The constant clamor of litigants and the demands of always being “fair” can make any judge irritable.  That never happened with Chancellor Chandler.  Sure he always ruled his courtroom and could be stern when that was needed.  But day in and day out he was good to be with even in the toughest trial.  Just the joy he took in the new courthouse in Georgetown was a pleasure to see, including giving tours of that courthouse when it first opened.

So what about the nominee to be Chancellor?  Even though he is named “Leo” he is well-suited for this job as Chancellor.  While not as patient as Chancellor Chandler (who is anyway?), Chancellor Strine has the intellectual honesty, intelligence, energy, administrative skills, and commitment to public service of the Williams who preceded him.  The Delaware Bar expects that he will fulfill his promise.
 

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Court Of Chancery Explains Attorney Fee Awards

In re Del Monte Foods Company Shareholders Litigation, C.A. 6027-VCL (June 27, 2011)

This is another in a series of detailed explanations of how attorney fees are to be calculated in representative litigation in Delaware.  First, the Court explained when an interim application may be considered, noting that it may be preferable to do so when the matter is still fresh.  That is particularly so when any appellate review is not likely to change the benefit conferred by the litigation.

Next, the Court explained that uncovering facts not known before the litigation began is particularly important and deserving of a fee award at the higher end.

Finally, the Court set out examples of prior fee awards and explained how those informed its decision in this case.

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Lewis Lazarus Authors Article on Plaintiffs' Pleading Burden in the Court of Chancery

Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | June 15, 2011

A plaintiff who pleads successfully that a transaction under attack is governed by the entire fairness standard of review instead of business judgment generally stands a good chance of defeating the defendant's motion to dismiss.  That is because when a transaction is reviewed for entire fairness, defendants bear the burden in the first instance of proving at trial the fairness of the process and price.

In two recent cases - Ravenswood Investment Co. v. Winmill and Monroe County Employees' Retirement System v. Carlson - the Court of Chancery clarifies that a plaintiff must still make well-pleaded allegations that a transaction is unfair as to process and price if its complaint is to survive dismissal at the pleadings stage.

Ravenswood involved claims that defendant directors' adoption of a performance equity plan violated fiduciary duties by seeking to dilute the minority stockholders' percentage interest in non-voting Class A shares (only Class B shares had voting rights).  The court noted that the entire fairness standard applied because "where the individuals comprising the board and the company's management are the same, the board bears the burden of proving that the salary and bonuses they pay themselves as officers are entirely fair to the company unless the board employs an independent compensation committee or submits the compensation plan to shareholders for approval."

Because the directors employed no such protective measures, the court held that the entire fairness standard of review applied.  Still, citing Monroe County, the court held that the plaintiff "bears the burden of alleging facts that suggest the absence of fairness."

The court dismissed the plaintiff's complaint because it found he had failed to make well-pleaded allegations that the defendant directors' adoption of the performance equity plan was unfair.  Critical to the court's reasoning was that dilution occurs upon the adoption of any options plan; the question is whether the manner in which the options were issued unfairly diluted the stockholders.

As the defendants in their motion to dismiss did not challenge the plaintiff's claim for unfair issuance of the options, the court found that the plaintiff's allegation of dilution did not suffice to state a claim for unfairness in the adoption of the performance equity plan.

This was so because the plaintiff alleged that "(1) the Performance Equity Plan only authorizes the Board to grant stock options with an exercise price not lower than the market value as of that event, (2) the Defendants already control all of the Company's voting rights through their ownership of its Class B shares, and (3) even if all options authorized under the plan were to be granted to the Defendants they would not obtain a majority interest in the Class A shares... ."

The court noted that although it was true that the Class A shares could vote to approve a merger, the plaintiff made no allegation in his complaint that the adoption of the performance equity plan impaired those voting rights.  The court declined to comment on whether such an allegation may have sufficed to sustain this claim.

The Ravenswood court relied upon the court's holding in Monroe County.  That case involved a challenge to an intercompany agreement that required the plaintiff's company to purchase services and equipment from its controlling shareholder on terms in conformity with (for services) or the same as (for equipment) what the controlling shareholder charged its other affiliates.  The parties agreed that the arrangement the plaintiff attacked was governed by the entire fairness standard of review.

They disagreed as to whether the plaintiff's pleading sufficed to survive a motion to dismiss.

As summarized by the court: "Delaware law is clear that even where a transaction between the controlling shareholder and the company is involved such that entire fairness review is in play, plaintiff must make factual allegations about the transaction in the complaint that demonstrate the absence of fairness. (citations omitted).  Simply put, a plaintiff who fails to do this has not stated a claim.  Transactions between a controlling shareholder and the company are not per se invalid under Delaware law. (citation omitted).  Such transactions are perfectly acceptable if they are entirely fair, and so plaintiff must allege facts that demonstrate a lack of fairness."

In reviewing the complaint, the court found no allegations that the price at which the controlling stockholder provided the services and equipment was unfair.  Instead, the court found that plaintiff's allegations addressed only alleged unfair dealing.

In the absence of an allegation that the company could have obtained the services or equipment on better terms from a third party or any specific allegation of the worth of the services or equipment relative to what the company paid, the court found that the complaint did not make sufficient factual allegations that the intercompany agreement transactions were unfair.  Because the plaintiff chose to stand on its complaint in response to the defendants' motions to dismiss rather than to amend, the court dismissed plaintiff's complaint with prejudice under Court of Chancery Rule 15(aaa).

Together, these two cases clarify that a plaintiff cannot survive a motion to dismiss simply by alleging that a transaction involving a controlling stockholder is unfair.  A plaintiff instead must make particular factual allegations suggesting why the transaction was unfair.  A plaintiff who cannot make such allegations and who stands on a conclusory complaint, as in Ravenswood, may find that its claims are dismissed with prejudice.

Lewis H. Lazarus (llazarus@morrisjames.com) is a partner at Morris James in Wilmington and a member of its corporate and fiduciary litigation group.  His practice is primarily in the Delaware Court of Chancery in disputes, often expedited, involving managers and stakeholders of Delaware business organizations.  The views expressed herein are his alone and do not necessarily reflect the firm or any of the firm's clients.
 

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Delaware Supreme Court Upholds Insider Trading Remedy

Kahn v Kolberg Kravis Roberts & Co. L.P., No.  436, 2010 (June 20, 2011)

One of the more important fiduciary duties in Delaware corporate law is not to trade on insider information.  A complaint alleging that you did is known as a Brophy claim for the decision that announced it over 60 years ago.  Recently, Brophy was thought to have been watered down by a requirement that the company actually suffer harm from the trading involved.  That would occur, for example, if the company is in the market to buy back its own stock in competition with the insider.

Well, the Supreme Court announced in this decision that it will not permit any chipping away at the Brophy rule.  It is not necessary to show harm to bring such a claim.  Rather, preserving the sanctity of fiduciary duties under Delaware law warrants permitting recovery of any profits made by the disloyal fiduciary, even if not at the company's expense.

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Court Of Chancery Resolves Demand Requirement For Statutory Trust

Hartsel v. The Vanguard Group Inc.,  C.A. 5394-VCP ( June 15, 2011)

Recently Delaware enacted a statute to authorize business trusts, such as used in the mutual fund industry, the Delaware Statutory Trust Act.  This decision establishes that the normal rules for derivative litigation apply in actions brought by trust interestholders.  For example, whether the action is direct or derivative and when demand is excused will be decided applying established Delaware law.

The decision also squarely establishes that the alleged mismanagement of investments by a mutual fund manager is a derivative claim.

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Court Of Chancery Denies Expedited Scheduling

In Re K-Sea Transpotation Partners L.P. Unitholders Litigation, C.A. 6301-VCP (June 10, 2011)

This decision on a motion to expedite the scheduling of a challenge to a merger is interesting for its extensive treatment of the merits of the complaint.  In the past, the Court of Chancery has treated motions to expedite more summarily.  Perhaps this indicates a greater focus on the burdens of expedition on the Court and others and a desire to limit expedition to those instances where otherwise a plaintiff would have no real remedy.

The opinion discussed in some detail when the possibility that a monetary judgment will be uncollectable is adequate to warrant expedition.  A real showing that is the case is required, not just speculation.

The opinion's other major holding is that a limited partnership agreement may effectively limit the amount of disclosures that must be given prior to a vote on a proposed merger.

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Why Do We Care About 'Poison Pills'?

This article was originally published in the Delaware Business Court Insider | June 08, 2011
 
Why do so many people care about whether the Delaware courts will continue to uphold the "poison pill" defense to a hostile takeover?  After all, comparatively few lawyers practice merger and acquisition law. Few companies are subject to hostile takeover threats, especially in recent years.  And who really stays up at night worrying about the fight between the two largely unknown companies that were the participants in Delaware's latest hostile takeover battle and the weapon of choice among defenders in such battles, the poison pill?

Yet, since the Feb.15 Court of Chancery decision in the Air Products case, there have been almost too-many-to-count blog postings, journal articles and symposia about that decision and its upholding of a poison pill. Who cares?
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Court Of Chancery Upholds LLP Dissolution Procedures

In re Cencom Cable Income Partners L.P. Litigation, C.A. 14634-VCN (June 3, 2011, revised June 6, 2011)

In this case the limited partnership agreement had a detailed method for dissolving the entity and paying the proceeds to the limited partners, including how to set the sale price if its assets were sold to a related party.  The General Partner approved such a sale and followed the prescribed method.  When the plaintiff argued the result was less than optimal, the Court held that was too bad when the partnership agreement was followed.  In short, the "contract" among the partners was again enforced.

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Court Of Chancery Explains When Staggered Board Elections Must Occur

Goggin v. Vermillion Inc., C.A. 6465-VCN (June 3, 2011)

The Delaware Supreme Court has held that when there are staggered terms for the members of a board of directors that the annual stockholders meetings must be about 1 year apart.  In this case, the next board meeting was set for June, 2011 or 6 months after the last meeting.  The Court held that was acceptable because the directors whose terms would expire at the new board meeting were elected 3 years ago.  Of course that left open whether continuing the new meeting date in 2012 might cut short the tems of other directors.  The Court declined to resolve that issue until the next meeting date was actually set.

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Superior Court Upholds Jurisdiction After Merger

Universal Capital Management Inc. v. Micco World Inc., C.A. 10C-07-039 RRC (June 2, 2011)

This is a useful case because it covers just about every basis to assert jurisdiction over non-Delaware residents for their actions in Delaware.  It also upholds jurisdiction over a former Delaware corporation that merged out of Delaware.

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Court Of Chancery Explains Need To Plead Unfairness Of Conflicted Deal

The Ravenswood Investment Company LP v. Winmill, C.A. 3730-VCN (May 31, 2011)

Some may think that all you need to state a claim for breach of fiduciary duty is to allege the action under attack involved a conflicted board.  Not so.  At the very least, a plaintiff also needs to allege facts that show the deal was unfair to the company.  Once that is pled, then the burden does shift to the conflicted board to justify the transaction.

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Court Of Chancery Explains How To Value A Derivative Claim In Merger

In re Massey Energy Company Derivative and Class Action Litigation, C.A. 5430-VCS (May 31, 2011)

When a company that is subject to derivative litigation is sold in a merger, the value of the derivative claim may be significant.  After all, in most cases, that claim passes to the buyer who arguably should pay something for it.  Here the Court carefully evaluated a derivative claim that it found would survive a motion to dismiss and explains why, in the circumstances of this case, that claim and its possible value did not mean the merger consideration was inadequate.

The way the Court does the analysis here is an excellent example of the way to value such a claim in the merger context.

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Court Of Chancery Explains Lead Counsel Selection Process

Nierenberg v CKx, Inc., C.A. 5545-CC (May 27, 2011)

This decision involves the application of the familiar standards governing the appointment of lead counsel, but with a twist.  When multiple suits are filed over the same alleged misdeed, the Court of Chancery has encouraged the litigants to file a so-called "Savitt Motion."  That motion asks the various courts involved to confer as to which case should go forward while the others are stayed. Here, when the New York court decided the Delaware case should be the one to proceed, the lead lawyer in New York agreed to drop his suit and go to Delaware with his claim. That drew praise from the Delaware court and may have tipped the balance in having that lawyer appointed lead counsel.

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