Delaware Business Litigation Report

Chancery Requires Fuller Disclosure for Receiver Appointment

In re VBR Agency LLC, C.A. No. 2022-0328-JTL (Del. Ch. Apr. 20, 2022)
Petitioners often call upon the Court of Chancery to appoint receivers to settle a company’s business. As this decision describes, “[i]n recent years, the members of the court have been forced to address actions taken by custodians or receivers who obtained appointments on … scant records. In some of those situations, the custodian or receiver has taken action that caused the court to question whether the appointment should have been made, or the court has learned information that might have caused the court to decline to make the appointment in the first instance. … Delaware has a significant interest in ensuring that questionable individuals do not use judicial proceedings to gain control over Delaware entities. Delaware likewise has an interest in ensuring that its entities are not used as vehicles for improper schemes.” Here, considering these concerns, the Court declined to make an appointment, first requiring additional information beyond that in the petition. The petitioner sought an appointment allegedly for the purpose of litigation involving a defunct LLC. The Court viewed as material additional information regarding the regulatory or legal histories of the receiver and any affiliates, as well as the receiver’s specific plans for the LLC beyond the general purposes stated in the petition.

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Chancery Addresses Fiduciary Duty Claims Involving Activist Investor

Goldstein v. Denner, C.A. No. 2020-1061-JTL (Del. Ch. May 26, 2022)
In this case, an activist investor and director was alleged to have concealed an eventual acquiror’s expression of interest while he leveraged that inside information to buy more stock and profit after the short-swing period’s expiration. And others at the company were alleged to have manipulated the company’s projections to justify the deal price at a lower valuation. The Court of Chancery found well-pled fiduciary duty claims against the alleged wrongdoers and aligned parties that avoided a Corwin dismissal. Among other things, the Court’s decision illustrates constellations of facts sufficient to question the independence of otherwise disinterested fiduciaries. Here, such combinations involved directors’ symbiotic relationships with an activist investor that resulted in repeat directorships in targeted companies.

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Chancery Upholds Standalone Direct Claim Under DGCL Section 155 Regarding Fractional Interests

Samuels v. CCUR Holdings, Inc., C.A. No. 2021-0358-PAF (Del. Ch. May 31, 2022)
Under Section 155 of the DGCL, corporations may elect either to issue stockholders fractional shares or to pay a stockholder the fair value of the fractional interest. The plaintiff-stockholder alleged that the corporation failed to pay him fair value for his fractional interest after a reverse stock split. In allowing a standalone claim under the statute to proceed, the Court reasoned that stockholders generally are permitted to assert direct statutory claims, and previous decisions addressing Section 155 did not foreclose the plaintiff’s statutory cause of action.

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Chancery Permits Novel Breach of Fiduciary Duty Claim Against Directors Who Refused Demand

Garfield v. Allen, C.A. No. 2021-0420-JTL (Del. Ch. May 24, 2022)
Historically, the wrongful rejection of a demand has affected only the question of who controls a derivative claim.  In this case, involving equity issuances to a director under an equity compensation plan, however, the plaintiff asserted that defendant-directors’ demand refusal constituted a separate breach of duty because the defendants did not correct an obvious violation of the plan’s plain language.  Although the Court recognized that the claim was potentially problematic from a policy perspective, the Court nonetheless found that the claim rested on the established principle that a conscious failure to act is the equivalent of action.  And the Court concluded that the plaintiff’s complaint established “one of the strongest possible scenarios for such a claim.”  Thus, the Court reasoned, it was reasonably conceivable that the defendants’ conscious inaction in the face of the plaintiff’s demand constituted a breach of the defendants’ duties.  

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Superior Court Sustains Certain Contract Claims in Dispute over Post-Acquisition Operation of Resort and Timeshare Business

CRE Niagara Holdings, LLC v. Resorts Group, Inc., C.A. No. N20C-05-157 PRW CCLD (Del. Super. Ct. May 31, 2022)
After acquiring a resort and timeshare business in 2017, plaintiffs brought claims of fraudulent inducement, breach of contract, and declaratory judgment against the seller. The seller filed claims in federal courts and in New York state court, and then separately filed parallel claims as counterclaims and a third-party complaint in Delaware. The seller alleged that plaintiffs did not adhere to past practices in operating the business post-acquisition, that they made the acquisition to loot the business, and that, as a consequence, the seller suffered from a diminution in value of the payment streams from certain contracts. The plaintiffs moved to dismiss the seller’s counterclaims and third-party complaint. More ›

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Chancery Enforces LLC Members’ Right to Approve Amendments to LLC Agreement

Zohar III Ltd. v. Stila Styles LLC, C.A. No. 2021-0384-JRS (Del. Ch. May 26, 2022)
This decision arises out of control disputes involving the portfolio companies of the entity Zohar III – here, the limited liability company Stila Styles LLC. Stila Styles’ Manager had approved via written consent a transaction that purported to create new units, with those new units controlling who served as the LLC’s Manager. The LLC agreement did authorize the Manager to create new units. But it generally authorized amendment or modification of the agreement “only by the Members.” Because the transaction effectively amended the LLC agreement by taking away certain Members’ rights respecting the Manager role, and the Manager did not obtain the Members’ approval, the Manager’s written consent approving the transaction was invalid and the transaction was void.

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Chancery Finds Officer Breached the Duty of Loyalty By Working With Competitors

Metro Storage Int’l LLC v. Harron, C.A. No. 2018-0937-JTL (Del. Ch. May 4, 2022)
The duty of loyalty requires that the corporation’s interests take precedence over any personal interest possessed by a director, officer, or controlling shareholder that is not shared by the stockholders generally. Relevant here, the plaintiffs alleged that the defendant had breached his fiduciary duty of loyalty by consulting for another company while he was an officer, failing to disclose that he was consulting for another company, usurping a financial opportunity, and misusing confidential information. The Court of Chancery found that the evidence supported all of these allegations. In particular, the Court found that the defendant breached his duty of loyalty by spending substantial time performing consulting work for another company when he had agreed to devote his full time to the plaintiff company. The Court reasoned that while an officer generally may work for an independent business so long as this work does not violate his fiduciary duties, the defendant had misappropriated company resources because he had agreed to spend his full time working for the company and this time was a resource that belonged to the company.

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Citing Novel Issues of Delaware Law, Chancery Declines to Dismiss Stockholder Class Action in Favor of First-Filed Securities Action

Lordstown Motors Corp. Stockholders Litig., CA. No. 2021-1066-LWW (Del. Ch. Mar. 7, 2022)
The Court of Chancery denied the defendants’ McWane motion to stay the case in favor of a first-filed federal securities action.  Because first-filed status matters less in representative actions, McWane correspondingly applies with less force.  Here, among the relevant factors, the Court of Chancery action involved novel Delaware legal issues, including the intersection of fiduciaries duty law and SPACs.  And the claims were not a mere rebranding as breaches of fiduciary duty of securities law claims based on allegedly misleading statements.  Thus, the Court concluded that Delaware’s substantial interest in providing guidance in emerging areas of Delaware law outweighed any practical or comity concerns that might otherwise warrant a stay.

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Chancery Declines to Grant Equitable Standing When Other Stockholders Had Standing to Enforce Corporate Rights

SDF Funding LLC v. Fry, C.A. No. 2017-0732-KSJM (Del. Ch. May 13, 2022)
Under Section 327 of the DGCL, a stockholder must hold stock at the time of the alleged wrong to have standing to pursue a derivative claim. Under the equitable standing doctrine, however, standing may be recognized in equity to prevent a “complete failure of justice.”  Here, the plaintiffs acquired the stock after some of the alleged wrongs in their complaint took place but argued that the equitable standing doctrine allowed one of them to raise these claims. The Court of Chancery observed that the doctrine has applied when alternative avenues of remedying the harm were foreclosed.  Importantly, however, the Delaware courts generally have declined to invoke it when other avenues theoretically exist, such as the existence of other potential plaintiffs with standing to pursue the claims at issue. Applying that reasoning here, the Court ruled that it would not grant equitable standing because other non-party stockholders would have standing to pursue these claims.

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Supreme Court Finds Enforceable Preliminary Agreement

Cox Communications v. T-Mobile, No. 340, 2021 (Del. Mar. 3, 2022)
Delaware courts have a “general aversion” to enforcing agreements to agree. But Delaware law also recognizes enforceable preliminary agreements that create an obligation to try to negotiate a final agreement on all material terms in good faith. Here, two companies, Cox Communications and T-Mobile, disputed whether a particular provision of a settlement agreement was enforceable and to what extent. The provision related to Cox partnering with a mobile network provider and generally obligated Cox to negotiate with T-Mobile. Those negotiations failed, Cox partnered with Verizon, and this suit resulted. The Court of Chancery entered an injunction that enforced the provision by prohibiting Cox from partnering with another provider besides T-Mobile. On appeal, the Delaware Supreme Court vacated the injunction and reversed, finding the provision left open several material terms of a future definitive agreement, was not itself an enforceable agreement, and instead was a “Type II” preliminary agreement that obligated the parties to negotiate open items in good faith. The Supreme Court remanded the case for a determination of whether the parties fulfilled that obligation.

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Court Rejects Franchisor’s Attempt Based on Business Effects of COVID-19 to Escape Contractual Obligation to Purchase Franchisee’s Assets

Level 4 Yoga, LLC v. CorePower Yoga, LLC, C.A. No. 2020-0249-JRS (Del. Ch. March 1, 2022)
In this post-trial decision, the Court of Chancery awarded specific performance to Plaintiff/franchisee who sought to enforce Defendant/franchisor’s exercise of its contractual right to purchase Plaintiff’s assets, which included yoga studios in several states.  Defendant exercised its right as of May 2019 but then delayed, and ultimately purported to back out, after the COVID-19 pandemic took hold in early 2020.  The Court granted specific performance based upon the specific language of the parties’ agreement, finding Defendant failed to prove either a Material Adverse Effect or a violation of the ordinary course covenant when Plaintiff temporarily closed its yoga studios in response to COVID-19.  Among other reasons, the seller was the franchisee, the buyer was the franchisor, and the seller had followed the buyer’s instructions concerning the operation of franchises.  The Court also noted that the parties’ agreement contained no closing conditions or an express right to terminate.

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Superior Court CCLD Determines D&O Insurance Policy Does not Cover Defense Costs in Statutory Appraisal Proceeding

MPM Holdings, Inc. v. Federal Ins. Co., C.A. No. N20C-07-014 MMJ CCLD (Del. Super. Ct. Mar. 17, 2022)
In recent years, the Delaware Supreme Court has pointed out that directors and officers liability insurance might not cover defense costs in statutory appraisal proceedings.  In In re Solera Insurance Coverage Appeals, 240 A.3d 1121 (Del. 2020), the Supreme Court held that an appraisal action is not a securities claim because it does not involve a violation of the law.  Subsequently, the Supreme Court affirmed a Superior Court decision that an appraisal action is not based on a wrongful act, but rather is a creature of statute and neutral in nature.  Jarden, LLC v. ACE American Ins. Co., 2021 WL 3280495 (Del. Super. Ct.), aff'd sub nom. Jarden LLC v. ACE American Ins. Co., 2022 WL 618962 (Del.). More ›

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Chancery Finds AT&T Failed to Satisfy Entire Fairness Review in a Freeze-Out of Minority Partners in Local Spectrum Partnership

In re Cellular Telephone P’ship Litig., Coordinated C.A. No. 6885-VCL (Del. Ch. Mar. 9, 2022)
A controller that stands on both sides of a freeze-out transaction has the burden to prove that its acquisition was entirely fair to minority partners in terms of the acquisition’s process and price. The freeze-out of minority partners at an opportune time for the controller may not satisfy entire fairness review. More ›

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Chancery Sustains Fiduciary Duty Claims Arising From Option Grants At Pandemic-Low Price

Knight v. Miller, C.A. No. 2021-0581-SG (Del. Ch. Apr. 27, 2022)
In mid-March 2020, at a time when the COVID-19 pandemic caused the corporation’s stock price to trade at a periodic low, the corporation’s compensation committee awarded stock options to themselves and other directors and officers. Addressing the defendants’ motion to dismiss, the Court reasoned that the circumstances did not support an inference of bad faith. Nevertheless, because the compensation committee members received options and thus were personally interested in determining their terms, such claims were subject to entire fairness review. Similarly, option grants to certain directors who together also were the corporation’s controlling stockholders would be subject to entire fairness review as involving non-ratable benefits to a controller. The Court rejected, however, the stockholder-plaintiffs’ theory that certain officer-defendants breached their fiduciary duty of loyalty by receiving the awards. Surveying prior cases, the Court reasoned that to sustain such a claim, the circumstances would have to be such that the recipient acted with scienter (i.e., in “bad faith”) by receiving the compensation at-issue. Finally, given that the awards potentially resulted from breaches of fiduciary duty by the director-defendants, the Court sustained at the pleading stage a claim that all recipients were unjustly enriched. 

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Chancery Parses Claims and Issues Subject to Mandatory Advancement Obligations

Krauss v. 180 Life Sciences Corp., C.A. No. 2021-0714-VCW (Del. Ch. Mar. 7, 2022).
The plaintiff was a former director and officer of a SPAC who became involved in litigation following its business combination. The certificate of incorporation and bylaws provided for mandatory advancement. Regarding several subpoenas to the plaintiff and her affiliated companies, although only one was brought “by reason of the fact” of her service as a director or officer, the Court granted advancement based on her counsel’s good faith certification for all work would have been done if there was only the one covered subpoena, even if such work also helped with her responses to non-covered subpoenas. The plaintiff’s affirmative defenses to a fiduciary duty action similarly were covered. Her compulsory counterclaims there also were covered. In so holding, the Court reasoned that, although the certificate of incorporation stated board approval was required for advancement in connection with certain litigation activities initiated by the indemnitee, the bylaws contained no such requirement. Certain counterclaims for breaches of registration rights agreements were not compulsory and were personal in nature, however, and so were not subject to advancement. The plaintiff was entitled to fees-on-fees proportionate to her success and pre-judgment interest from the date she provided invoices evidencing those costs; although the invoices redacted various time entries, her counsel certified that she did not seek advancement for those amounts.

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