Posts in Derivative Claims

Court of Chancery Approves Awards Large Fees!

A few recent articles have questioned the willingness of the Court of Chancery to award adequate fees in class and derivative litigation. These articles focus on one or two instances where fee requests were not met with full approval. This anecdotal approach is misleading. After all, it would be a sign of a failing system if every fee request were given blanket approval regardless of its merits.

Two more recent decisions by the Court of Chancery show it is fully responsive to appropriate fee requests and is willing to award large fees when appropriate. In the McKesson/HBOC litigation, Chancellor Chandler  awarded the plaintiff's attorneys $10 Million for their years of hard work on behalf of McKesson in a derivative suit. More recently, Vice Chancellor Strine in the Hollinger case awarded plaintiff's counsel $2,500,000 in fees for his work in a case where the actual litigation work was fairly brief, but the results were outstanding.

Both of these cases were what are known as Caremark cases alleging that the Board had failed to perform its oversight duty to avoid accounting and other problems. That type of case is fairly characterized as among the most difficult to prove, given the high standard to establish liability.  Thus, when the plaintiffs won a good settlement, their attorneys were rewarded, fairly and even generously.

In short, bring a good case, fight hard, achieve a decent result and the Court of Chancery will reward your effort. That is all we should expect.

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Court of Chancery Explains When Directors Are Interested In The Deal

In Re Primedia Inc. Derivative Litigation, C.A. No. 1808-N (Del. Ch. November 15, 2006).

This case dealt with when directors would be considered interested in a deal so as to preclude the application of the business judgment rule and permit the suit to proceed.  Many of the directors were affiliated with the controlling stockholder who had purchased the corporation's preferred stock at a deep discount just before the board voted to redeem that stock at its face value. That decision was justified, it was argued, because the coupon rate on the stock was higher than market rate. The Court held that might well be so, but at the pleading stage it was too soon to accept that as a justification for the purchase that gave the controlling stockholder a big gain. The decision is particularly interesting for its discussion of when directors are considered sufficiently connected to a controlling stockholder so as to preclude application of the business judgment rule. More ›

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Federal Court Permits Motion To Transfer Using Multi-Factor Balancing Test

Weisler v. Barrows, C.A. No. 06-362 GMS, 2006 WL 3201882 (D. Del. Nov. 6, 2006).

Plaintiff, a shareholder of Sycamore Networks, Inc. (“Sycamore”), a Delaware corporation with its principal place of business in Massachusetts, brought this derivative action against several of its directors and officers, including its chairman, CEO and CFO. The complaint alleged six counts: (1) a count against each director for section 14(a) violations of the Securities and Exchange Act of 1934 (“Exchange Act”); (2) one count of disgorgement against four directors under section 304 of the Sarbanes-Oxley Act of 2002 (“Oxley Act”); (3) one count of breach of fiduciary duty against all directors; (4) one count of unjust enrichment against five directors; (5) one count of gross mismanagement against all defendants; and (6) one count of waste of corporate assets against all defendants.

The defendants moved to transfer the matter pursuant to 28 U.S.C. § 1404(a) and the Court granted the motion because it would convenience the parties and witnesses and serve the interests of justice.

The plaintiff alleged that the defendants had jointly and severally breached their fiduciary duties of care, loyalty, good faith, and candor by failing to: (1) discover or prevent the intentional manipulation of stock option grants between 1999 and 2004; (2) prevent the misreporting of earnings that was caused by the manipulation of the option grants; (3) oversee the administration of Sycamore’s stock-based compensation plans; (4) ensure Sycamore operated in compliance with applicable state and federal laws pertaining to dissemination of financial statements; (5) ensure the company did not engage in any improper or illegal practices; and (6) ensure that the company’s financial statements were compliant with GAAP. The conduct is alleged to have violated section 14(a) of the Exchange Act and section 304 of the Oxley Act.

The Court permitted the transfer of the matter on its individualized consideration of the motion under section 1404(a) and on whether it would convenience the parties and witnesses and serve the interests of justice. The Court also held that it was the defendants’ burden to establish the need for transfer. The Court observed that the standard for transfer did not demand a demonstration of compelling circumstances; rather, the defendants only needed to show that the case would be better off if transferred to the other jurisdiction. That inquiry required a “multi-factor balancing test” that consisted of not only the convenience of the parties and the witnesses but also the examination of certain public and private interests. The Court listed the private interests as: (1) a plaintiff’s choice of forum; (2) the defendant’s preference; (3) where the claim arose; (4) the convenience of the parties and witnesses; and (5) the location of the books and records. The Court listed the public interests as: (1) the judgment’s enforceability; (2) practical trial considerations making it easy, expeditious or inexpensive; (3) the administrative difficulty presented in the two fora; (4) local interest in deciding the controversy at home; and (5) the public policies of the fora under consideration. The Court found that the private and public factors weighed in favor of transfer and therefore permitted the defendants’ motion.

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Court of Chancery Rejects Attempt To Revive Derivative Suit

West Coast Management & Capital LLC v. Carrier Access Corporation, C.A. No. 2262-N (Del. Ch. November 14, 2006) is a classic example of what can go wrong in trying to plead a derivative suit. The Court of Chancery dismissed the complaint because the plaintiff had filed a prior complaint in federal court that had been dismissed for failure to establish that demand on the directors was excused. Here, the plaintiff tried to pursue a stockholder inspection claim to establish that demand was excused, but the Court held it was precluded from doing so by the dismissal of its prior complaint. This shows that a plaintiff better know what it is doing when it files a derivative suit because the chances to correct errors will be limited. More › Share

Supreme Court Interprets The "Duty" To Act In Good Faith

Stone v. Ritter,  C.A. No. 93, 2006 (Del. Supr. November 6, 2006).

The Supreme Court has issued the latest Delaware decision to interpret the duty to act in good faith. Indeed, it is possible to read Stone as holding there is no separate duty of directors to act in good faith. While that would be a mistake, the implications of this decision may be far reaching. At the very least, Stone upholds the conventional wisdom in Delaware that under Caremark the directors' duty to act is most easily triggered when there are red flags indicating something is wrong with the way the entity is being operated. A complaint that fails to plead those red flags has a good chance of being dismissed. More ›

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Court of Chancery Rejects Balancing Test Under Rule 23.1

Bakerman v. Frank Importing Co. Inc., C.A. No. 1844-N (Del. Ch. October 16, 2006). When directors own shares in both the parent and its subsidiary, the question arises whether they are disinterested in considering a demand under Rule 23.1 in a case challenging a transaction between the two entities. This decision holds that the Court will test their interest in the transaction by focusing on their interest in the dominant party and will not also take into account their interest in the entity on the other side of the transaction. This makes sense because otherwise the Court would need to do a complex balancing to see if the interest in the subsidiary was as important as the interest in the parent. That involves tax and other issues that are difficult to determine. Note, however, that after discovery, those interests may be balanced in deciding on the merits if the directors should be given the benefit of the Business Judgment Rule. More › Share

Court of Chancery Holds 5 Days Is Too Short For Merger Announcement

Berger v. Intelident Solutions Inc., C.A. No. 1527-N (Del. Ch. October 12, 2006). Under Delaware law, when a stockholder files suit over a merger she may be limited to appraisal rights when her concern is only over the price to be paid. It is often difficult to decide when a complaint is limited to the price and does not also deal with unfair dealing claims that are appropriate for class litigation. Here, the Court held that a complaint that alleged only 5 days notice of a merger and the right to seek appraisal did properly allege unfair dealing and could proceed as a class claim. Share

District Court Applies Exception to Tooley Test and Rejects Argument That Exculpatory Provisions Create Contractual Obligations

Shamrock Holdings v. Arenson, C.A. 06-62-SLR, 2006 WL 2802913 (D. Del. Sept. 29, 2006). This case involved a dispute between the Class A and Class B members of a Delaware LLC called ALH Holdings. The dispute arose after ALH faced financial trouble and the Class A members voted to sell the company over the objections of the Class B members, who eventually threatened to sue. To preempt such a suit, the Class A members brought an action for a declaratory judgment that, among others, they did not breach their fiduciary duties or the LLC's operating agreement. In response, the Class B members counterclaimed, alleging breaches of the same. Plaintiffs subsequently moved for summary judgment as to four of the counts in their complaint, and they moved to dismiss the defendants' counterclaim. The Court denied the motion to dismiss and denied the motion for judgment on the pleadings in part (and granted it in part). More › Share

Supreme Court Adopts "Validly In Litigation" Rule

Braddock v. Zimmerman, C.A. No. 489 (Del. Sup. September 12, 2006). The Delaware Supreme Court has clarifed the rules as to when a plaintiff in a derivative suit must make a demand upon filing an amended complaint. The Court holds that if the derivative litigation has been properly instituted an amendment to the complaint does not need to be the subject of a demand on the board of directors as to those claims already "validly in litigation". Thus, even if the majority of the board has changed and is now independent under Rule 23.1 standards, no demand need be made in those circumstances. More › Share

Court of Chancery Limits Creditor Fiduciary Duty Claims

North American Catholic Educational Programming Foundation, Inc. v. Gheewalla, C.A. No. 1456-N (Del. Ch. September 1, 2006). This is another in a series of Court of Chancery decisions that limit the claims that creditors may make based on the theory the directors owe the creditors a duty when their corporation is insolvent or in the vicinity of insolvency. Ever since the famous footnote in Credit Lyonnais Bank Nederland, N.V. v. Pathe Communications Corp., 1991 WL 277613 (Del. Ch. Dec. 30, 1991), creditors have argued that directors should owe them a fiduciary duty to take their interests into account when the creditors are the residual interest holders in a corporation that is insolvent or nearly so. A series of recent decisions have limited those creditor arguments. See e.g. Production Resources Group, L.L.C. v. NCT Group, Inc., 863 A.2d 772 (Del. Ch. 2004) [holding most creditor claims must be brought as derivative claims]. This new decision further limits creditor claims by holding that creditors may not bring a direct claim for breach of fiduciary duty based on the theory the entity is in the vicinity of insolvency. Further, the decision holds that for clearly insolvent companies, only creditors whose claims are beyond fair dispute may claim the directors owe them a duty. More › Share

Supreme Court Clarifies Tooley

<a href="http://www.delawarebusinesslitigation.com/archives/gentile.pdf" Gentile v. Rossette, C.A. No. 573, 2005 (Del. Supr. August 17, 2006). This Delaware Supreme Court decision significantly clarifies the Court's Tooley decision that governs when a claim is a derivative claim. Because a derivative claim must meet significant pleading requirements under Court of Chancery Rule 23.1, this decision affects much of the corporate litigation in the Delaware Court of Chancery and merits careful reading. More › Share

Court of Chancery Rejects Deepening Insolvency Theory

Trenwick America Litigation Trust v. Ernst & Young LLP, C.A. No. 1571-N, 2006 WL 2333201 (Del. Ch. Aug. 10, 2006). The Delaware courts have struggled for the last fifteen years over the scope of the duties of directors to creditors when their company is in the vicinity of insolvency. In two landmark decisions, the first in 2004, and just recently, the Court of Chancery sought to define the limits of that duty. Indeed, in this decision the Court rejected the very idea that there is a duty to avoid taking risks that may have the effect of deepening the insolvency of a Delaware corporation, at least in most circumstances. More › Share

Court of Chancery Sustains Complaint Attacking Settlement

Kosseff v. Ciocia, C.A. No. 188-N, 2006 WL 2337593 (Del. Ch. Aug. 3, 2006). In this decision, the Court dealt with a complaint attacking the transaction implemented to settle a proxy contest. The proxy contest was settled by an agreement that put the dissidents on the board and had the CEO resign. However, the CEO was given the right to buy certain lucrative businesses of the company, a right he later exercised. The complaint alleged that this deal was improvident. After reviewing the complaint, the Master declined to grant a motion to dismiss. More › Share

Rule 23.1 Requirements Are Satisfied By Business Relationships

AIG Retirement Services, Inc. v. Barbizet, C.A. No. 974-N, 2006 WL 1980337 (Del. Ch. July 11, 2006). Business relationships between directors may sometimes make them unqualified to pass upon demands their company sue their fellow directors. This is such a case where the board members derived substantial benefits from their relationships with the potential target of litigation the plaintiff demanded be brought. Under those circumstances, the futility of making a demand under Rule 23.1 was easily established. Share

Court of Chancery Grants Defendants' Motion to Dismiss Where Plaintiffs Asserted Derivative, Not Direct, Claim and Failed to Make Demand or Establish Demand Was Excused

Gatz v. Ponsoldt, C.A. No. 174-N, 2006 WL 1510467 (Del. Ch. May 26, 2006). Plaintiffs asserted direct claim arising from recapitalization. Defendants moved to dismiss, arguing that Plaintiffs' claim was actually derivative, not direct, and Plaintiffs had failed to make demand or establish demand was excused. More › Share