Posts tagged Case Summaries

Court of Chancery Extends Books And Records Inspection

Melzer v. CNET Networks, Inc., C.A. No. 3023-CC (November 21, 2007).

The scope of inspection rights may be affected by when a stockholder first acquired her stock. If the inspection is to investigate alleged wrongdoing, the rationale for granting inspection is to permit the filing of a derivative suit if the inspection shows that it is warranted. Hence, prior case law has held that inspection of records existing before the petitioner became a stockholder is not warranted because the stockholder has no right to sue for those pre-ownership wrongs under Delaware law.

This decision extends inspection rights when the potential claim is for a Caremark case alleging a "sustained or systematic failure" of oversight. Then, the Court held, showing past failures is relevant to showing a sustained wrong that culminated in damage to the entity after the petitioner became a stockholder. Under that rationale, the scope of inspection may extend to pre-ownership records.

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Court of Chancery Holds Advancement Lost Despite Conversion

Bernstein v. Tractmanager Inc., C.A. No. 7263-VCL (November 20, 2007).

This decision illustrates the perils in converting from an LLC to a corporate form without considering the consequences. Here, the LLC involved did not provide for mandatory advancement rights. The LLC was then converted into a Delaware corporation whose bylaws did provide for advancement as a matter of right. Quite possibly this was thought to be a good idea as the attorney who did the conversion was about to be sued by the entity and was a director who now thought he was covered. Unfortunately, the LLC did not provide for advancement and the Court of Chancery held that it was the LLC's operating agreement that controlled the right to advancement. Thus, advancement was denied.

The lesson here is that in converting from one form of entity to another do not assume that the new entity is obligated to fulfill all the obligations that might have been the responsibility of its predecessor. That was the losing party's argument. The problem was that the LLC was not obligated to him and thus, there was no liability to follow upon conversion. If you want the new entity to be liable then say so.

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Supreme Court Upholds Preferred Stock Provision

Hildreth v. Castle Dental Centers, Inc., Del. Sup. C.A. No. 195, 2007 (November 15, 2007).

A tricky issue arises when a defective certificate of incorporation causes stock to be void. Here, the preferred stock was validly authorized but there was not enough common stock to fulfill the conversion rights of the preferred. The Supreme Court held that the defect was with the common stock, not with the preferred. Hence, one defect in the "contract" will not invalidate the whole contract.

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Superior Court: No Ambiguity, No Extrinsic Evidence, No Dice

Dubuque v. Taylor, 2007 WL 3106451 (Del. Super. Oct. 1, 2007)

This case demonstrates that a Delaware court will not consider extrinsic evidence of the parties’ intent at the time of entering an agreement if the terms of the document are unambiguous.

The buyer/plaintiff purchased a transmission business called Goodeal Discount Transmissions of Dover, Inc., thinking it was a sole proprietorship. But after the closing, the franchisor—not the seller—came knocking on the buyer’s door seeking unpaid franchise fees and stating the amount to be paid going forward. Soon thereafter, the buyer sued the seller/former owner for breach of contract for failing to disclose that the business was a franchise, for breach of the contractual warranties, and for fraudulent misrepresentation.
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Court of Chancery Upholds Objective Theory of Contract Interpretation

Seidensticker v. The Gasparilla Inn Inc., C.A. No. 2555-CC (November 8, 2007).

In this decision, the Court of Chancery has once again held that a contract means what it says, not what the parties say they subjectively intended. Thus, if the contract is unambiguous in its language, the Court will not accept explanations of what it was supposed to mean. Instead, the Court will enforce the contract as written. This opinion is useful for its review of recent case law that some have suggested adopted a "subjective" theory of contract interpretation under which, as the Cheshire Cat once said, "A word means what I say it means." Not so in Delaware.

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District Court Finds No Ambiguity or Third Party Beneficiary Status, Grants Motion for Summary Judgment

MBIA Ins. Corp. v. Royal Indem. Co., 2007 WL 3125319 (D.Del. Oct. 25, 2007)

In this opinion the District Court resolved cross-motions for summary judgment on the defendant’s counterclaim for breach of contract. The relationship between the plaintiffs and the defendant arose out of the underwriting of student loans. Student Finance Corporation (“SFC”) underwrote loans to students using funds from banks, then allegedly fraudulently issued “forbearance payments” in order to hide delinquent and defaulting loans. SFC transferred the loans to several trusts, which then issued fixed income notes, called Certificates, to investors. Plaintiff #1 was the trustee of trusts holding the securitized student loans. Defendant insured the loans that backed the Certificates with insurance policies that unconditionally guaranteed the students’ repayment of principal plus 90 days interest. Plaintiff #2 guaranteed payment of the Certificates in the event that the Defendant failed to honor its policies on the loans. Plaintiffs sued Defendant seeking to enforce its unconditional guarantee to repay the loans. Defendant counterclaimed against Plaintiff #1 for breach of contract, arguing that Plaintiff #1 did not adequately fulfill its oversight responsibilities under applicable Pool Servicing Agreements (“PSAs”) with respect to the servicing of the loans, and thus did not discover the allegedly fraudulent forebearance payments, resulting in Defendant engaging in continual transactions with SFC. Plaintiffs’ claim for enforcement of Defendant’s guarantee obligation was settled, leaving the Court only Defendant’s counterclaim to resolve.  More ›

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Court of Chancery Explains Limits of Requirements Contract

XO Communications LLC v. Level 3 Communications Inc., C.A. No. 2131-VCL (November 2, 2007).

While the actual terms of a contract will control its meaning, there are occasions when legal rules will determine the result of a contract dispute. Here, the Court of Chancery noted the rule that in the case of a requirements contract, it is bad faith for the buyer to produce for its own use the materials that it committed to buy from the other party  to the contract. The Court held that rule did not apply when at the time the requirements contract was entered into, the buyer had the means of producing the goods it had agreed to buy from the other party as well. In short, the requirement was not to use the producing party exclusively.

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Court of Chancery Explains Fair Summary Rules

In re Checkfree Corporation Shareholders Litigation, C.A. No. 3193-CC (November 1, 2007).

Exactly what needs to be included in a proxy statement for a merger vote seems to be a constant subject for debate. Only a "fair summary of the substantive work performed by the investment bankers" need be disclosed, not everything given to them. Moreover, when there is no competing bid, then to enjoin the merger the court must be convinced that a strong showing has been made of disclosure errors.

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Court of Chancery Explains Limitations Period

In re Coca-Cola Enterprises Inc. Shareholders Litigation, C.A. No. 1927-CC (October 17, 2007).

In breach of fiduciary duty cases, a frequent question is when to apply the three-year statute of limitations that applies to actions at law. Here, the Court again holds that the statute of limitations begins to run in a breach of fiduciary duty case when the parties enter into their contract and not when the harm resulting from that contract occurs.

Thus, when the complaint alleged that Coca-Cola was abusing its bottling company under the  terms of a 1986 contract, the breach ran from 1986, not from when Coca-Cola took certain actions under that contract in 2004. Time and again, the Court has used this approach to reject late claims or claims asserting a so-called continuing wrong theory where the limitations period never expires.

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Court of Chancery Upholds Very Broad Arbitration Clause

Ornero v. Country Grove Investment Group LLC, C.A. No. 2245-VCS (October 12, 2007).

In this case the contract required arbitration of any dispute between the parties arising from "any other cause", not just from a cause related to their contract. The Court upheld the claim that even a suit on a dispute unrelated to the contract containing the arbitration clause was within this broad arbitration agreement.

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Court of Chancery Interprets Partner Duties

Forsythe v. ESC Fund Management Co., C.A. No. 1091-VCL (October 9, 2007).

The duties of a general partner in a Delaware limited partnership are governed by the partnership agreement. But when those duties may be delegated to third parties under the terms of the partnership agreement, the GP duties are less clear. Here, the Court had to decide if the scienter required by the Caremark case applied to hold the GP liable if red flags pointed to abuses by the parties running the show or whether instead the general partnership obligations of a GP to be responsible for its agents was the standard to apply.

Recognizing that in this case the authority to delegate to third party managers with clear conflicts of interest put the GP on notice, the Court held that the GP had more than just Caremark-like duties -there was a duty of more active inquiry.

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District Court Applies Delaware Statute of Limitations Carve Out For Fiduciary Claims, Denies Summary Judgment

Norman v. Elkin, 2007 WL 2822798 (D.Del. Sept. 26, 2007)

In this action the District Court evaluated the application of the statute of limitations to claims that a corporate fiduciary engaged in self-dealing at the corporation’s expense. Plaintiff was a 25% shareholder in a closely-held Delaware corporation with Pennsylvania headquarters, formed to participate in the wireless communications industry. Defendant #1 owned the remaining shares of the corporation, and also served as its President and sole director. Plaintiff alleged that Defendant #1 breached his duties to the corporation when he personally obtained newly-issued communications licenses from the FCC, then sold them along with the corporation’s pre-existing licenses to a third party, keeping the proceeds of the sale himself. Plaintiff further alleged that Defendant #1 took the action without notifying Plaintiff in his capacity as a shareholder, without holding an annual meeting, and without making any disclosure of the sale. Plaintiff sued Defendant #1, along with his wholly owned corporation and another corporate officer, in the Delaware Court of Chancery for breach of contract, unjust enrichment, declaratory relief, and breach of various fiduciary duties. Defendants removed the action to District Court based on diverse citizenship and moved for summary judgment, arguing that all claims were time-barred. More ›

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District Court Grants All Motions to Dismiss in Anti-Trust Class Action

Howard Hess Dental Laboratories Inc. v. Dentsply Int'l, 2007 WL 2807292 (D.Del. Sept. 26, 2007)

This opinion resolved several motions filed in two different antitrust class actions (the “Hess” action and the “Jersey Dental” action). The District Court denied Plaintiffs’ motion for partial summary judgment in the Hess action and granted various Defendants’ motions to dismiss in the Jersey Dental action. Plaintiffs were dental laboratories that purchased dental products from one Defendant, Dentsply, a manufacturer and distributor of dental products. In the Hess action, Plaintiffs sued Dentsply for alleged antitrust violations in connection with an adopted policy providing that dental dealers promoting Dentsply’s product not add competitive product lines. In the Jersey Dental action, Plaintiffs sued Dentsply and twenty six dental dealers alleging antitrust violations arising from the same Dentsply policy.  More ›

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Court of Chancery Holds Arbitrator Decides If Claim Is Arbitrable

Baypo Limited Partnership v. Technology JV, C.A. No. 2693-VCL (October 10, 2007).

Many arbitration clauses contain provisions that permit a court to grant injunctive relief.  These are used because of a fear that the arbitration panel may not have that power and that sort of relief may be needed, such as to enforce a noncompetition clause. Notwithstanding the presence of such clause, this decision upholds the usual Delaware rule that it is up to the arbitrators to decide if an issue is subject to the arbitration provision. Of course, that does not mean they decide if a court may hear an application for an injunction.

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Court of Chancery Explains The "Some Evidence" Rule In Section 220 Cases

Louisiana Municipal Police Employees Retirement System, C.A. No. 2608-VCN (October 2, 2007).

To obtain inspection of corporate records to investigate allegations of wrongdoing, it has long been held that a stockholder must have "some evidence" that there was indeed wrongdoing to investigate. Otherwise, mere allegations would permit intrusive books and records reviews.

Here, the allegation was that options had been back dated and the Court permitted inspection based on a statistical analysis that showed stock price rises immediately after many option grants. The Court felt this was "some evidence" that warranted inspection. However, the Court was clearly skeptical and cautioned that it was going to continue as the gate keeper to limit inspections that were not justified.

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