Delaware Quarterly Recent Developments in Delaware Business and Securities Law
July - September 2013 Volume 2, Number 3
The Delaware Supreme Court and Delaware Court of Chancery are generally regarded as the country’s premier business courts, and their decisions carry significant influence over matters of corporate law throughout the country, both because of the courts’ reputation for unsurpassed expertise in the field and because the vast majority of public companies in the United States are incorporated in Delaware and, thus, governed by its substantive law. Accordingly, Delaware’s corporate jurisprudence provides critical guidance to corporations, alternative entities and practitioners in evaluating corporate governance issues and related matters.
DQ HIGHLIGHTS Delaware Quarterly: July 2013 – September 2013....................... 2 In re Trados Incorporated Shareholder Litigation......................................................... 2 Southeastern Pennsylvania Transportation Authority v. Volgenau...... 6 Additional Developments In Delaware Business And Securities Law................... 10
Each calendar quarter, the Delaware Quarterly analyzes and summarizes
Alternative Entities...............................10
key decisions of the Delaware courts on corporate and commercial issues,
Appraisals................................................ 12
along with other significant developments in Delaware corporate law.
Arbitration............................................... 12
The Delaware Quarterly is a source of general information for clients and friends of Winston & Strawn, LLP, which is also contemporaneously published in the Bank and Corporate Governance Law Reporter. It should not be construed as legal advice or the opinion of the Firm. For further information about this edition of the Delaware Quarterly, readers may contact the Editors, the Authors, or any member of the Advisory Board listed at the end of this publication, as well as their regular Winston & Strawn contact.
Books and Records................................ 13 Class Actions........................................... 14 Contracts................................................. 14 Corporate Governance........................ 15 Derivative Actions................................. 16 Expedited Proceedings........................ 17 Fiduciary Duties..................................... 17 Fraud......................................................... 17 Indemnification....................................... 18 Jurisdiction.............................................. 18 Practice and Procedure........................ 18
EDITORS Jonathan W. Miller
[email protected] +1 (212) 294-4626
James P. Smith III
[email protected] +1 (212) 294-4633
Matthew L. DiRisio
[email protected] +1 (212) 294-4686
Privileges.................................................20 Settlement Proceedings ...................... 21
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Delaware Quarterly: July 2013 – September 2013 By Jonathan W. Miller, Matthew L. DiRisio, Corinne D. Levy, Jill K. Freedman, Ian C. Eisner, Anthony J. Ford, Lee A. Pepper, Allison G. Castillo and Shawn R. Obi Among other decisions of note this quarter, the Delaware Court of Chancery issued a pair of potentially wide-ranging opinions in the context of mergers and acquisitions litigation. First, the court entered its post-trial opinion in the long-running entire fairness case In re Trados Incorporated Shareholder Litigation, granting judgment to defendant directors against claims that they breached their fiduciary duties by approving a merger in which the deal consideration was usurped almost entirely to fund preferred stockholders’ liquidation preference. The court ruled in defendants’ favor notwithstanding that (i) the common stockholders received no consideration for their shares, and (ii) the court found the board’s sale process unsatisfactory under the entire fairness standard, primarily based on its conclusion that the fair value of the company’s common stock at the time of the merger was zero. The court’s holding thus suggests that the fair price prong of the entire fairness test can trump the fair process element, at least after a trial on the merits. Second, the court continued its recent focus on going-private transactions involving controlling stockholders in Southeastern Pennsylvania Transportation Authority v. Volgenau. On the heels of its recent landmark opinion in In re MFW Shareholders Litigation, which held that a statutory freezeout merger effected by a controlling stockholder can earn business judgment rule protection where it is conditioned on the front end on the approval of both (i) a fully empowered, independent special committee and (ii) a nonwaivable, fully-informed majority vote of uncontrolled shares, the court in Volgenau confirmed that the same protections will justify business judgment review of a take-private transaction involving the sale of a controlled company to a third-party buyer, even where the controller will roll over a portion of its equity interest in the surviving entity. Each of these matters is discussed in greater detail below, followed by synopses of the quarter’s other Delaware decisions across a range of topics, including: alternative entities; appraisals; books and record actions; class actions; contract in-
Winston & Strawn LLP | 2 terpretation; corporate governance issues; derivative actions; expedited proceedings; fiduciary duties; fraud; indemnification; jurisdiction; privileges; settlements; and other matters of Delaware practice and procedure.
In re Trados Incorporated Shareholder Litigation The Court of Chancery recently issued its post-trial opinion in In re Trados Incorporated Shareholder Litigation, a long-running shareholder suit seeking appraisal and alleging breaches of fiduciary duty by the directors of TRADOS Inc. (“Trados”) in connection with its sale to SDL plc for $60 million in July 2005.1 The company’s common stockholders received none of the merger consideration, which went primarily to the preferred stockholders (Trados’ venture capital investors). In 2009, then-Chancellor Chandler declined to dismiss the fiduciary duty claim, holding that directors could breach their fiduciary duties by favoring the interests of preferred stockholders over those of common stockholders where those interests diverge. Revisiting that issue, Vice Chancellor Laster’s post-trial decision found that, while Trados’s board failed to follow a fair process in selling the company by improperly favoring the interests of the preferred stockholders, there was ultimately no breach of fiduciary duty because the common stockholders received a fair price for their shares – namely, nothing.
Background Trados is a Delaware corporation that originally developed desktop translation software.2 In the late 1990s, the company sought to grow by entering the enterprise software market and attracting large corporations and government entities as customers.3 It then sought venture capital funding and set its sights on an eventual IPO.4 Throughout the early 2000s, Trados received multiple rounds of funding from several venture capital firms. Those firms received various classes of preferred stock and the right to designate directors on the Trados board.5 The preferred stock carried a liquidation preference, a standard feature of venture capital funding that provides 1 2 3 4 5
C.A. No. 1512-VCL, 2013 WL 4516775 (Del. Ch. Aug. 16, 2013). Id. at *2. Id. Id. See id. at *2-4.
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Delaware Quarterly for preferred stockholders to be paid first in any liquidation event, such as a sale or wind-down of the company.6 By 2002, five of Trados’s directors were venture capital designees.7 By 2004, Trados had grown steadily, but more slowly than its venture capital backers had hoped,8 and the investors began resigning themselves to a best-case scenario of simply recovering the amount of their original investments. When Trados’s growth faltered in early 2004, the board replaced the CEO and engaged an investment bank to begin exploring in earnest the possibility of a sale of the company.9 The only offer that process produced was a $40 million bid from SDL, a global technology firm.10 The board rejected that offer and the new CEO began focusing on shoring up Trados’s cash position and revenue to increase its attractiveness in a potential sale.11 The venture capital investors declined to contribute any additional capital.12 Under the leadership of its new CEO, Trados’ position improved through 2004.13 SDL continued to express interest in acquiring Trados.14 To incentivize senior management to pursue a sale, the board unanimously voted to adopt a management incentive plan (“MIP”) that would provide senior executives with a percentage of the sale proceeds in the event Trados was sold.15 Importantly, the MIP included a cutback feature that would reduce recipients’ MIP payout by the amount of any consideration they received as equity holders, thus focusing their interests exclusively on the MIP proceeds rather than any proceeds received by virtue of their common stock.16 In early 2005, board discussions returned to potential exit scenarios, focusing on a handful of parties as possible acquirors, including SDL.17 The board settled on $60 million as the target price, as one of its venture capital investors refused to sell for any less.18 Amid solid quarterly results, Trados’s CEO presented the $60 million price to SDL, which agreed to acquire Trados at that price.19 In June 2005, the Trados board
Winston & Strawn LLP | 3 approved the merger.20 At that time, the board consisted of Trados’ CEO and CFO and five venture capital designees.21 Given that Trados’s preferred stockholders had the right to vote on an as-converted basis with common stockholders, between Trados’ venture capital investors and other stockholders friendly to management, there were sufficient votes to obtain the necessary approval of both preferred and common stockholders.22 Under the MIP, the first 13% of the $60 million merger consideration ($7.8 million) went to senior management.23 As the total liquidation preference on the preferred stock at the time of the merger was $57.9 million, the entirety of the remaining $52.2 million went to the preferred stockholders, leaving nothing for the common stockholders.24
The Proceedings In July 2005, a holder of 5% of Trados’s common stock filed an appraisal action in the Court of Chancery.25 In 2008, based on discovery obtained in the appraisal proceeding, the plaintiff filed a class action against Trados and its former directors in the Court of Chancery, alleging that the former directors had breached their fiduciary duties by approving the merger26 and the two actions were consolidated before then-Chancellor Chandler. Defendants motion to dismiss was denied in significant part on the grounds that “in circumstances where the interests of the common stockholders diverge from those of the preferred stockholders, it is possible that a director could breach her duty by improperly favoring the interests of the preferred stockholders over those of the common stockholders.”27 After the Chancellor’s retirement, the action was reassigned to Vice Chancellor Laster. Following defendants’ unsuccessful motion for summary judgment, the case proceeded to trial.
The Court’s Analysis The Standard
6 7 8 9 10 11 12 13 14 15 16 17 18 19
See id. at *2-3. See id. at *2-4. See id. at *4-6. See id. at *5-7. See id. at *7-8. See id. at *8-9. Id. at *8. Id. at *9. See id. at *9-10. Id. at *7, *10. Id. at *10. See id. at *10-11. Id. at *11. Id. at *13.
In its post-trial decision, the court began by noting that while the Trados directors obviously owed fiduciary duties to the 20 21 22 23 24 25 26 27
Id. at *14. See id. at *21-23, *29-30. See id. at *15. See id. at *14. Id. at *15. Id. at *16. Id. In re Trados Inc. S’holder Litig., C.A. No. 1512-CC, 2009 WL 2225958, at *7 (Del. Ch. Jul. 24, 2009). Return to top
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corporation and its stockholders,28 they did not owe such duties to the preferred stockholders with respect to their preferred rights since, as then-Chancellor Chandler recognized in his decision on the motion to dismiss, the rights of preferred stockholders are contractual in nature. Common stockholders, on the other hand, provide the corporation’s equity capital and are residual claimants, requiring directors to maximize the value of the corporation for their ultimate benefit.29 Generally, therefore, “it will be the duty of the board … to prefer the interests of the common stock … to the interests created by the special rights, preferences, etc. … of preferred stock.”30
plaintiffs had proven at trial that the directors had not dealt fairly with the common stockholders.37 The defendants produced no evidence indicating that the directors sought to protect the interests of common stockholders throughout the sale process.38 Rather, the court found, the venture capital directors decided to pursue a sale so that their firms could exit Trados, recoup their invested capital (through their preferred stock liquidation preference), and free up their resources for more promising ventures.39 In short, the venture capital directors pursued the merger to take advantage of the preferred stockholders’ special cash-flow rights, which diverged from the interest of common stockholders.40
Next, the court held that, because the Trados board lacked a majority of disinterested and independent directors, the applicable standard of review was entire fairness, rather than the deferential business judgment rule or some intermediate level of enhanced scrutiny.31 The court found that plaintiffs had proven at trial that six of the seven directors had conflicts of interest with respect to the sale of Trados.32 Specifically, two of the directors (the CEO and CFO) received significant payments under the MIP and were offered employment by SDL following the merger, while three other directors were fiduciaries of venture capital firms that received significant payments under the preferred stock’s liquidation preference.33 A sixth director, the plaintiffs proved, had a strong relationship with one of Trados’s venture capital investors which compromised his independence, and, as a preferred stockholder, he received a modest but material payment under the liquidation preference.34
The court likewise found the structure of the transaction to be indicative of unfair dealing toward the common stockholders,41 because the MIP was disproportionately funded by common stockholders and therefore favored the preferred.42 Had the board not adopted the MIP, $57.9 million of the $60 million merger consideration would have gone to preferred stockholders to satisfy the entire liquidation preference, leaving $2.1 million for distribution to the common stockholders. Under the MIP, on the other hand, the first $7.8 million went to management, with preferred stockholders receiving all of the remaining $52.2 million in partial satisfaction of the liquidation preference. Accordingly, the common stockholders in effect contributed all of their merger proceeds to the MIP, while preferred stockholders contributed only about 10% ($5.7 million of the $57.9 million liquidation preference). There was no evidence at trial that the board considered how to fairly allocate the consideration remaining after the liquidation preference or whether it could obtain a higher price such that common stockholders would receive some value in the transaction.43
Under entire fairness, the defendants must, of course, establish that the transaction was the product of both fair dealing and fair price.35 But at the same time, the court observed, the entire fairness test is not “bifurcated” between fair dealing and fair price; rather, “[a]ll aspects of the issue must be examined as a whole since the question is one of entire fairness.”36 Fair Dealing First taking up the issue of fair dealing, the court found that 28 2013 WL 4516775, at *17. 29 See id. at *18-19. 30 Id. at *19 (quoting Equity–Linked Investors, L.P. v. Adams, 705 A.2d 1040, 1042 (Del. Ch. 1997)). 31 See 2013 WL 4516775, at *20-21. 32 See id. at *21. 33 Id. at *21-23. 34 Id. at *30. 35 Id. at *21 (quoting Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1163 (Del. 1995)). 36 2013 WL 4516775, at *30 (quoting Weinberger v. UOP, Inc., 457 A.2d 701, 711 (Del. 1983)).
The MIP also skewed the incentives of the management directors. As holders of options and common stock, the interests of Trados’s CEO and CFO were initially aligned with common stockholders,44 but the MIP provided them with substantial direct payments in the event of a sale and its cutback feature, which reduced management’s MIP payouts by the amount of any consideration received as equity holders and ensured that they had no incentive to maximize value for
37 38 39 40 41 42 43 44
See 2013 WL 4516775, at *31. See id. See id. See id. at *31-32. Id. at *32-33. See id. at *33-34. See id. at *34. See id. Return to top
Delaware Quarterly common stockholders by seeking a higher price.45 Thus, the court found,“[t]he MIP converted the management team from holders of equity interests aligned with the common stock to claimants whose return profile and incentives closely resembled those of the preferred.”46 Finally, the manner in which the board approved the transaction evidenced unfair dealing toward common stockholders insofar as “[t]he defendants in this case did not understand that their job was to maximize the value of the corporation for the benefit of the common stockholders, and they refused to recognize the conflicts they faced.”47 The court noted that there were no board minutes evidencing consideration of the interests of common stockholders and no director who testified at trial could recall any specific discussions to that effect.48 Faced with the reality of the divergent interests between the preferred and common stockholders, the board could have formed a special committee or obtained a fairness opinion, but did neither.49 (Indeed, the court noted, use of a special committee could actually have resulted in application of the business judgment rule rather than entire fairness review.)50 Fair Price Turning to fair price, the court considered the valuations and testimony of each of the parties’ expert witnesses. While rejecting the defendants’ theory that Trados was a failing business that would have entered bankruptcy if not for the merger, the court ultimately found their expert’s discounted cash flow analysis credible.51 Specifically, even though that analysis employed reasonable, “plaintiff-friendly” assumptions, it still resulted in a present value of only $51.9 million for Trados at the time of the merger – significantly less than the $60 million merger consideration.52 Reviewing all of the evidence, the court went on to conclude that the value of the common stock at the time of the merger was zero, as Trados simply would not have been able to grow at a rate that would have yielded value for common stockholders.53 This was because the preferred stock’s large liquidation preference and cumulative dividend created a “gravitational pull” that Trados would not have been able 45 46 47 48 49 50 51 52 53
See id. at *35. Id. Id. at *35. Id. at *36-37. Id. at *37. Id. at *37 n.39. See id. at *45-46. See id. at *46-48. See id. at *48-49.
Winston & Strawn LLP | 5 to escape, even had it been able to continue operating with modest growth.54 Each common stockholder thus “receive[d] the substantial equivalent in value of what he had before” – nothing – in satisfaction of the fairness test.55 In short, even though the directors did not deal fairly with the common stockholders, their fiduciary duties were not ultimately breached because, as they successfully proved at trial, the transaction – which gave nothing to common stockholders whose interests were worth nothing – was entirely fair.56
Takeaways While the facts of Trados may in some respects be specific to the venture capital context, certain more broadly applicable corporate governance takeaways are apparent. First, while Vice Chancellor Laster held that the price rendered the transaction entirely fair under the circumstances even though the board did not deal fairly with common stockholders, it remains to be seen to what extent this reasoning will be followed by other members of the Court of Chancery. After all, established Delaware Supreme Court precedent holds that, under entire fairness, defendants must establish “to the court’s satisfaction that the transaction was the product of both fair dealing and fair price.”57 Second, as the court noted, a director’s failure to fully understand his or her duties and recognize conflicts is indicative of unfair dealing. (Such conflicts may arise from the special rights of preferred stock (as here) or any other circumstance where directors receive payments or benefits from a transaction that are not shared with common stockholders.) Accordingly, directors must recognize that they have a duty to maximize value for the common stockholders and take appropriate steps to ensure that result, including, first and foremost, express consideration of the interests of the common stockholders and identification of potential conflicts, appropriately memorialized in board minutes. Finally, as the court explicitly noted here, and as other recent decisions of the Court of Chancery make abundantly clear, protective procedural measures – such as forming a special committee, obtaining a fairness opinion, or requiring approval of a majority of disinterested common stockholders – may be critical to ensuring a fair process, particularly when a 54 Id. at *48. 55 Id. (quoting Sterling v. Mayflower Hotel Corp., 93 A.2d 107, 114 (Del. 1952)). 56 See 2013 WL 4516775, at *49. 57 Cinerama, Inc. v. Technicolor, Inc., 663 A.2d 1156, 1163 (Del. 1995). Return to top
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majority of directors face potential conflicts. Indeed, as the court observed, the formation of an independent and disinterested special committee could actually result in the application of the deferential business judgment rule rather than entire fairness review—a difference that could very well prove dispositive.
Southeastern Pennsylvania Transportation Authority v. Volgenau
58
In recent years, the Delaware Court of Chancery has consistently chipped away at the Delaware Supreme Court’s broad edict in Kahn v. Lynch Communication Systems, Inc.59 that a freeze-out merger between a controlling stockholder and the controlled company must be scrutinized under the stringent entire fairness standard of judicial review, given the inherent potential for controller exploitation of minority stockholders.60 A few months ago, in its most aggressive step away from Kahn to date, the Court of Chancery held in In re MFW Shareholders Litigation61 that a statutory merger between a controlling stockholder and its subsidiary could escape entire fairness review in favor of the deferential business judgment standard if, in principal part, the controlling stockholder at the outset of the sale process conditions the transaction on the approval of both (i) an independent and fully empowered special committee and (ii) a non-waivable, fully-informed and uncoerced vote of a majority of the minority stockholders. What has remained unanswered, at least directly, is the related but separate issue of the standard of review applicable to the sale of a company with a controlling stockholder to a third party, as opposed to a transaction directly between a controller and the controlled company. The court touched upon that issue in In re John Q. Hammons Hotels Inc. Shareholder Litigation, where it applied the entire fairness standard in analyzing a third-party sale of a controlled company, but suggested that such transactions could garner protection under the business judgment rule in the presence of “sufficient procedural protection for the minority stockholders.”62 58 C.A. No. 6354-VCN, 2013 WL 4009193 (Del. Ch. Aug. 5, 2013). 59 638 A.2d 1110, 1117 (Del. 1994). 60 Among other things, the Court of Chancery has distinguished statutory mergers effected by a controller, as in Kahn, from tender offers conducted by controllers, finding that the latter structure – which affords minority stockholders the freedom to tender into the offer or not – might avoid entire fairness review by implementing certain procedural protections designed to protect minority stockholders from coercion. See, e.g., In re CNX Gas Corp. S’holders Litig., 4 A.3d 397 (Del. Ch. 2010); In re Pure Res., Inc., S’holders Litig., 808 A.2d 421 (Del. Ch. 2002). 61 67 A.3d 496 (Del. Ch. 2013). 62 2009 WL 3165613, at *2, *10 (Del. Ch. Oct. 2, 2009).
In Southeastern Pennsylvania Transportation Authority v. Volgenau, Vice Chancellor Noble confirmed what then-Chancellor Chandler presaged in Hammons: the sale of a controlled company to a third-party buyer can warrant business judgment review – even where a controlling stockholder retains an equity interest in the surviving company – if proper procedural mechanisms are utilized (i.e., approval by an independent special committee and a nonwaivable, fully-informed majority vote of minority stockholders).
Background Volgenau arose from a take-private transaction of SRA International, Inc. (“SRA”), a leading provider of technology solutions and professional services founded in 1978 by Ernst Volgenau, the controlling stockholder of SRA since its inception and a member of its board of directors. SRA had two classes of common stock: Class A, entitled to one vote per share; and Class B, entitled to ten votes per share. Through his Class B ownership, Volgenau held approximately 71.8% of SRA’s stockholder voting power. Under the terms of SRA’s charter, the holders of Class A and Class B common stock were required to be treated equally in the event of a merger. In 2010, amid declining growth rates, lower profit margins and poorly performing acquisitions, Volgenau became interested in a leveraged buy-out (“LBO”), which would, in theory, provide stockholders with a substantial premium while simultaneously preserving SRA’s values and culture – a primary concern for Volgenau that, at least initially, soured him on the idea of a strategic acquisition. In the spring of 2010, Providence Equity Partners LLC and its affiliates (collectively, “Providence”) contacted and met with Volgenau (and, subsequently, other SRA management) about a possible LBO and received proprietary information about the company pursuant to a confidentiality agreement. After considering various alternatives – which included a failed effort to acquire another technology services company – SRA turned its attention to Providence.63 To that end, the SRA board formed a special committee comprised of five directors, with Michael Klein serving as Chair. The special committee retained Houlihan Lokey (“Houlihan”)64 as its financial advisor and Kirkland & Ellis (“Kirkland”) as its legal 63 In this time frame, the SRA board formed a “study team” to consider the company’s strategic alternatives. The study team retained financial advisor CitiGroup, who concluded that a significant acquisition of another company in the technology services sector would best allow SRA to maximize its long-term value. 2013 WL 4009193 at *5. 64 Houlihan Lokey was represented in this litigation by attorneys at Winston & Strawn LLP. Return to top
Delaware Quarterly counsel. At a November 22, 2010 meeting with Providence representatives, Klein, on behalf of the committee, informed Providence that (i) SRA had decided not to undertake a formal sale process and (ii) Providence’s initial $28 per share expression of interest was insufficient to commence formal discussions. Consequently, Klein permitted Providence additional diligence, but rejected its request for exclusivity. On December 1, 2010, Serco, a strategic competitor of SRA, made an unsolicited proposal to acquire SRA at a price range of $29-$31 per share, which Klein promptly shared with Providence, purportedly in an effort to evoke a higher offer.65 When Providence instead responded by lowering its offer price from $28.00 to $27.25 per share, the special committee decided to open up the process and explore additional third-party interest. Over the next six months, the special committee, through Houlihan, conducted a sale process that ultimately included six financial buyers (including Providence and Veritas Capital (“Veritas”)) and four strategic buyers who signed confidentiality agreements and conducted diligence.66 Notably, the process was “bifurcated” – Volgenau was allowed to meet with strategic acquirers to discuss his “humanistic concerns” for the company, while the special committee handled all negotiation of deal terms. To that end, the special committee expressly instructed Volgenau not to have any communications with potential bidders without special committee authorization. The sale process culminated in only two formal offers, from Providence and Veritas. After a multi-round bidding contest between the two firms, the special committee eventually decided to accept Providence’s final offer: $31.25 per share of common stock (those held by Volgenau and by minority stockholders), conditioned upon Volgenau rolling over $150 million of his ownership stake and agreeing to use a portion of it to fund a $30 million non-recourse loan to Providence (to be repaid only if SRA realized certain profit thresholds 65
While plaintiff highlighted Klein’s transmission of the proposal to Providence – in which he indicated that SRA intended to “fend[] off” Serco’s overture pending receipt of Providence’s proposal – as indicia of his effort to improperly steer the deal, the court ultimately characterized the message as a negotiation tactic. Id. at *6. 66 The special committee declined to initially solicit other strategic buyers beyond Serco in order to safeguard confidential and proprietary information and avoid leaks into the marketplace. Id. at *6-7. By mid-January, however, the markets began to speculate that SRA had received acquisition proposals. As a result of the speculation, (i) Serco withdrew its preliminary offer and terminated discussions and (ii) the special committee opened the process up to potential strategic acquirers. Id. at *7.
Winston & Strawn LLP | 7 from the sale of two subsidiaries). Based on, inter alia, the special committee’s unanimous recommendation and Houlihan’s opinion that the consideration was fair, the board (absent Volgenau, who abstained) unanimously approved the merger. In its final form, the merger was subject to: (i) a 30day go-shop provision; (ii) a two-tiered breakup fee – $28.2 million during the go-shop and $47 million afterwards; (iii) a reverse breakup fee of $112.9 million; and (iv) a non-waivable affirmative vote by a majority of SRA stock not owned or controlled by Volgenau. The go-shop period, during which Houlihan solicited 50 potential bidders, including 29 strategic buyers and 21 financial sponsors, yielded no additional interest, and, on July 15, 2011, 81.3% of the total outstanding shares not owned or controlled by Volgenau voted in favor of the merger, which closed on July 20, 2011. Stockholders received a 52.8% premium over SRA’s closing stock price on the last unaffected trading day. Southeastern Pennsylvania Transportation Authority (“SEPTA”) filed suit shortly thereafter, asserting claims for: (i) breach of fiduciary duty against the SRA board for approving the merger pursuant to an inadequate process and for an unfair price; (ii) breach of fiduciary duty against Volgenau and Stanton Sloane, the former CEO of SRA, for engaging in self-dealing; (iii) breach of fiduciary duty against the SRA board for approving the merger in violation of the “equal treatment” provision in SRA’s charter; and (iv) aiding and abetting the board’s breach of fiduciary duty against Providence. Defendants moved for summary judgment.
The Court’s Analysis The Standard of Review The court began its analysis by distinguishing the recent MFW case, where it recognized an exception to the traditional rule that freeze-out transactions with a controlling stockholder on both sides are necessarily subject to entire fairness review where the controller, on the front end, conditions the transaction on the approval of both an independent and fully empowered special committee and a non-waivable, fully-informed and uncoerced vote of a majority of the minority stockholders.67 Here, by contrast, the sale was not to the controller itself but to a third party. Moreover, the court found that Volgenau’s planned equity rollover, pursuant to which he would retain an interest in the surviving entity, did not by itself place him “on both sides” of the deal. Under Delaware 67 Id. at *10, citing MFW, 67 A.3d at 501-02, 514-16. Return to top
Delaware Quarterly law, “[w]hen a corporation with a controlling stockholder merges with an unaffiliated company, the minority stockholders of the controlled corporation are cashed-out, and the controlling stockholder receives a minority interest in the surviving company, the controlling stockholder does not stand on both sides of the merger.”68 Accordingly, the court found its decision in Hammons, which addressed third party acquisitions of controlled companies, to be the applicable precedent. In Hammons, the court reasoned that a third-party transaction involving a controlling stockholder should qualify for business judgment review where: (i) it is recommended by a disinterested and independent special committee with “sufficient authority and opportunity to bargain on behalf of minority stockholders,” including the “ability to hire independent legal and financial advisors”; (ii) it must be (and is) approved by a non-waivable majority vote of the minority stockholders; and (iii) the stockholder vote is fully informed and free of coercion.69
• Special
Committee Independence. The court agreed with the defendants that the special committee was disinterested and independent. Most notably, the court found that Klein’s request to the board for a $1.3 million bonus for his service on the committee did not impugn his independence, because the payment would be made in the form of donations to two charities with which Klein was affiliated. Since the compensation would go to charity, and not Klein personally, the court found that he did not have a material conflict of interest in the merger. The court likewise found that neither Klein nor Volgenau dominated the special committee, concluding based on record evidence that: (i) all special committee members were involved in the sale process and deliberations; (ii) the special committee opened the bidding process to strategic buyers despite Volgenau’s initial desire to limit the process to financial sponsors; and (iii) the special committee bargained hard against Providence and Veritas, ultimately prompting a $4 increase in merger consideration.
• Majority-Of-The-Minority
Provision. Plaintiff did not dispute that the merger was subject to a non-waivable majority of the minority vote, but argued that the vote was not fully informed. Specifically, plaintiff challenged the omission of information regarding: (i) the exploratory meetings between the SRA board of
68 Frank v. Elgamal, 2012 10960690, at *7 (Del. Ch. Mar. 30, 2012) (internal quotations omitted). 69 Hammons, 2009 WL 3165613, at *12.
Winston & Strawn LLP | 8 directors and Providence; (ii) Klein’s “wishful thinking” regarding his request for the charitable contribution; (iii) Kirkland’s compensation, which was partially contingent on a deal being undertaken; (iv) why Veritas withdrew from the auction process; (v) how the SRA board of directors determined that the merger conformed with the equal treatment requirement in SRA’s charter; and (vi) CitiGroup’s previous work for SRA and relationship with Providence. The court disagreed, reciting the familiar maxim that Delaware law does not require that companies “bury the shareholders in an avalanche of trivial information,”70 or provide a “play-by-play description of every consideration or action taken by a Board.”71 Ultimately, the court found that plaintiff had failed to meet its burden of showing that the omitted facts would have significantly altered the total mix of information available to stockholders.72 In sum, given the bona fides of the special committee and majority-of-the-minority provision, the court determined that the applicable standard of review was business judgment, under which directors’ decisions are entitled to “great deference” and will not be second-guessed or examined for reasonableness where they “can be attributed to any rational business purpose.”73 Unfair Price and Process The court rejected plaintiff’s contention that the SRA directors breached their fiduciary duties by approving a merger at an inadequate price and pursuant to a flawed sale process. In doing so, the court emphasized that the $31.25 per share merger price marked the highest price any party was willing to pay after a six-month public sale process and a thirty-day go-shop, and constituted a 52.8% premium over SRA’s unaffected stock price. Additionally, the court noted Houlihan’s opinion that the merger consideration was fair, from a financial standpoint, to minority stockholders, and, indeed, that the merger was approved by 81.3% of the total outstanding shares not owned or controlled by Volgenau. On these bases, the court concluded that there was no triable issue of material fact that a rational mind could have considered the merger price fair. The court similarly dismissed plaintiff’s process-based claims, noting, among other things, that the board 70 Volgenau, Op. at 49 (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 448-49 (1976)). 71 2013 WL 4009193 at *19 (quoting In re Cogent, Inc. S’holder Litig., 7 A.3d 487, 511-12 (Del. Ch. 2010)). 72 Id. at *20. 73 Id. at *21(quoting Paramount Commc’ns Inc. v. QVC Network, Inc., 637 A.2d 34, 45 n. 17 (Del. 1994)) (internal quotations omitted). Return to top
Delaware Quarterly formed a special committee of independent and disinterested directors which retained its own independent financial and legal advisors, and, pursuant to the record evidence, fully exercised its obligation of due care in approving the merger. Therefore, the court found that there was no triable issue of material fact that the decisions made by the special committee and the board of directors were attributable to a rational business purpose, and the court refused to substitute its judgment for that of the SRA directors. Self-Dealing Plaintiff’s self-dealing claims against Volgenau and Sloane alleged that Volgenau wrongfully steered the sale process toward Providence, his “preferred bidder,” and that Sloane sought to facilitate that transaction in order to receive a bonus. The court found each claim unavailing under the business judgment standard. First, the court noted that, while Volgenau was initially (and admittedly) wary of strategic transactions out of concern for company culture, he eventually grew comfortable with the idea of selling his shares to a strategic buyer, once he became familiar with them and their plans for the company going forward. Second, the court found no evidence that Volgenau “orchestrated a preordained deal with Providence that the Special Committee merely rubber-stamped,” or that any strategic buyer was dissuaded from bidding because of Volgenau’s emphasis on culture and values. Finally, the court held that Volgenau did not receive more consideration for his shares than minority stockholders by virtue of his rollover equity interest. On the contrary, by agreeing to a risky $30 million non-recourse promissory note to Providence, the repayment of which was contingent on future earnings of SRA subsidiaries, Volgenau actually “sacrificed his economic position for the minority stockholders.”74 The “Equal Treatment” Charter Provision Vice Chancellor Noble then turned to plaintiff’s claim that the SRA board breached its fiduciary duties by approving a merger that, by granting Volgenau a rollover equity interest in the surviving company, violated the “equal treatment” provision in SRA’s charter by apportioning greater consideration to Volgenau than to the public stockholders. The court rejected these allegations, holding that the “plain language of the equal treatment clause plainly permits differing forms of consideration.”75 Although the court recognized that the precise value of Volgenau’s consideration might be a material issue of fact, it was undisputed that the board, including Volgenau, 74 Id. at *24. 75 Id. at *25.
Winston & Strawn LLP | 9 believed that the consideration being received by Volgenau was equal to or less than that received by minority stockholders, and came to that conclusion rationally after valuing the various forms of consideration. Finally, the court noted any breach of the charter provision would constitute a duty of care violation, for which the directors would be exculpated from liability under the company’s 8 Del. C. § 102(b)(7) provision in SRA’s charter.
Conclusion Once the court (i) found “no genuine issue of material fact as to whether Volgenau [stood] on both sides of the transaction,”76 and (ii) determined that the special committee process and majority-of-the-minority provision complied with the strictures of Hammons necessary to invoke business judgment protection, it was a short jump to uphold the merger as “attributable to a rational business purpose” and grant judgment to the defendants.
Takeaways First, the Volgenau decision confirms what was largely preordained by the Hammons and MFW decisions: the sale of a company with a controlling stockholder to a third party can secure business judgment protection where it is (i) recommended by a disinterested and independent special committee and (ii) approved by a nonwaivable majority vote of minority shares. Most significantly, the court held that a rollover equity interest for the controller – common in take-private transactions of controlled companies – does not render the controller impermissibly conflicted such that he or she necessarily stands on both sides of the deal. In that regard, one interesting question in the wake of Volgenau is how the court will analyze a third-party sale where the controller receives exactly the same consideration as minority stockholders. The court has suggested in the past – and in its recent decision in In re Morton’s Restaurant Group, Inc. Shareholders Litigation – that such “equal treatment” would provide a safe harbor for a sell-side board to invoke business judgment review without even reaching the Hammons analysis.77 Second, notwithstanding the road map Volgenau provides, it is not clear whether the incidence of nonwaivable majority-of-the-minority provisions will increase in any material way, given the deal risk the provisions pose to controlling 76 Id. at *12. 77 C.A. No. 7122-CS (Del. Ch. Jul. 23, 2013) (finding that a 27.7% stockholder was not a controller for purposes of judicial scrutiny, but that even if he was, fact that he was receiving the same consideration as minority stockholders means it was not a conflict transaction). Return to top
Delaware Quarterly stockholders and the other options available. Among other things, structuring a deal as a tender offer rather than a statutory merger might allow a controller to evade entire fairness review without an iron-clad majority-of-the-minority provision. As the court noted in MFW, several Delaware cases have maintained the analytical dichotomy between mergers and tender offers and suggest that controllers in the latter framework do not have the same equitable duties to minority stockholders as those in the former. Third, it bears emphasizing that the Volgenau case was decided on summary judgment, and it is unclear how the holding will translate to the pleading stage of merger litigation. Indeed, the court relied on record evidence in determining, among other things, that the special committee was intimately involved in deliberations and that the board’s belief that Volgenau was not receiving greater consideration than minority stockholders was reasonable. In that regard, Volgenau serves as another reminder of the importance of documenting a robust sale process. Of note here, the defendants’ contention that Volgenau did not dominate the process was bolstered considerably by special committee minutes reflecting an explicit instruction prohibiting Volgenau from communicating with bidders absent special committee authorization.
Additional Developments In Delaware Business And Securities Law Beyond those topics addressed above, the Delaware courts also issued noteworthy decisions in the following areas of law during the past quarter.
Alternative Entities Attorneys’ Fees
• In ASB Allegiance Real Estate Fund v. Scion Breckenridge
Managing Member LLC,78 Vice Chancellor Laster granted a partial award of attorneys’ fees and expenses to plaintiffs after they had prevailed in an action against defendants to reform three joint venture agreements. Plaintiffs argued that they were entitled to attorneys’ fees and expenses as a matter of equity because defendants’ conduct giving rise to, and during the litigation involved bad faith and fraud. Specifically, plaintiffs asserted that one of defendants’ principals discovered a scrivener’s error in one of the joint venture agreements during the drafting process. But rather than alert plaintiffs of the mistake, defendants attempted to benefit from the error
78 C.A.5843-VCL, 2013 WL5152295 (Sept. 16, 2013)
Winston & Strawn LLP | 10 after the agreement had been executed by exercising a put right. The court found that while this pre-litigation conduct was “regrettable,” it did not support a bad faith fee award. The court did, however, find that defendants’ conduct during the litigation, including their knowing reliance on “unfounded” expert testimony and decision to file three lawsuits against ASB in three different jurisdictions to drive up litigation costs, constituted bad faith conduct warranting an order granting plaintiffs fees and expenses incurred as a result of defendants’ misconduct. Breach of Contract
• In
Stewart v. BF Bolthouse Holdco, LLC,79 Vice Chancellor Parsons denied in part and granted in part defendants’ motion to dismiss certain breach of contract claims brought by former employees of a Delaware LLC against the company and its board of managers. The dispute arose out of BF Bolthouse Holdco, LLC’s (“Bolthouse”) repurchase of the former employees’ membership units. Plaintiffs alleged that Bolthouse and its managers breached both the contract that governed the terms of the repurchase transaction and the terms of the company’s LLC agreement by valuing the membership units at $0.00 in bad faith. The court found that plaintiffs sufficiently stated a claim that the fair market value of the units was greater than $0.00 and that defendants acted in bad faith in valuing the units. The court applied the standard articulated in Clean Harbors, Inc. v. Safety-Kleen, Inc.,80 which requires a plaintiff to allege sufficient “facts related to the alleged act taken in bad faith, and a plausible motivation for it.”81 The court found that, while none of the allegations of bad faith were sufficient on their own, taken together, it was reasonably conceivable that defendants failed to act in good faith when valuing the units. The court also found that plaintiffs sufficiently alleged a plausible motivation for defendants’ bad faith conduct. However, the court dismissed plaintiffs’ claims for breach of fiduciary duty and breach of the implied covenant of good faith and fair dealing, finding that these claims were foreclosed by, and duplicative of, the breach of contract claims.
79 C.A. No. 8119-VCP, 2013 WL 5210220 (Aug. 30, 2013). 80 2011 WL 6793718 (Del. Ch. Dec. 9, 2011). 81 Id. Return to top
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Contract Interpretation
• In Natural Energy Development, Inc. v. Shakespeare-
One Limited Partnership,82 Chancellor Strine, in a memorandum opinion, held that plaintiff, the former general partner of Shakespeare-One L.P. (“ShakespeareOne”), had a vested right to a general partnership interest, thereby granting plaintiff a portion of ShakespeareOne’s profits. Defendants had conceded that plaintiff had not been properly removed from the position of general managing partner of Shakespeare-One, but subsequently amended the partnership agreement to provide that if plaintiff resigned or was removed as managing general partner, then plaintiff would forfeit the general partner interest. The court analyzed the terms of the partnership agreement in which plaintiff was clearly named managing general partner even though plaintiff had not been acting as such for a period of time. The court found that the agreement vested plaintiff with the general partner interest based on plaintiff’s prior services to Shakespeare-One. Plaintiff also sought a declaration that it was not the managing general partner of Shakespeare-One, which defendants did not oppose. The court granted plaintiff’s request, finding that it would have been inequitable to require plaintiff be the general partner against its will. The court declined to grant plaintiff’s request for attorneys’ fees.
Fiduciary Duties
• In Allen v. Encore Energy Partners, L.P.,
the Delaware Supreme Court affirmed the dismissal of a class action complaint challenging the merger of a limited partnership with its general partner’s controller. The Court held that the plaintiff did not raise a reasonable inference that defendants breached their duty of subjective good faith under the limited partnership agreement when approving the merger and, in so holding, confirmed that where contractual language modifies default common law fiduciary duties, the Court will enforce the contract. Plaintiff, a limited partner of Encore Energy Partners, LP (“Encore”), alleged that the general partner, its controller, and its board of directors violated duties imposed upon them under the limited partnership agreement in connection with the merger. Recognizing that the Delaware Revised Uniform Limited Partnership Act was intended to give “maximum effect to the principle of freedom of contract,” the Supreme Court found that the 83
82 C.A. No. 4836-CS, 2013 WL 3809250 (Del. Ch. Jul. 22, 2013). 83 C.A. No. 534, 72 A.3d 93 (Del. Jul. 22, 2013).
partnership agreement eliminated common law fiduciary duties and only required that defendants act in “good faith” with regards to Encore. Under the agreement, good faith required a subjective belief that actions taken would be in the best interests of Encore. Thus, to adequately plead a breach of the good faith standard, plaintiff needed to show either that the independent directors: (i) consciously disregarded their contractual duty to form a subjective belief that the merger was in Encore’s best interest; or (ii) believed that they were acting against Encore’s best interests in approving the merger. The Court found that plaintiff failed to meet these burdens, noting that it would take an extraordinary set of facts to do so.
• In
Grove v. Brown,84 Vice Chancellor Glasscock, in a post-trial memorandum opinion, held that Marlene Grove and Larry Grove, two members of Heartfelt Home Health, LLC (“Heartfelt”), a home health care agency, breached their fiduciary duty of loyalty by forming competing health care agencies without informing the other two members of Heartfelt, Melba Brown and Hubert Brown. The court also rejected an attempt by the Browns to merge Heartfelt into a new entity solely owned by the Browns. While the operating agreement provided that each member owned 25% of Heartfelt, the Browns alleged that because the Groves had not paid the full amount of their required capital contributions, the Browns owned 63% of Heartfelt and thus had the authority to effectuate the merger. The court disagreed, finding that the operating agreement did not provide that a member’s failure to make the required capital contribution would divest that member of his or her share of the company.
Indemnification
• In Costantini v. Swiss Farm Stores Acquisition LLC,
85
Vice Chancellor Glasscock, in a letter opinion, held that Edmond D. Costantini (“Costantini”), a former managing member of Swiss Farm Stores Acquisition LLC (“Swiss Farm”), was entitled to indemnification, but that James Kahn (“Kahn”), a partner of a managing member of Swiss Farm, was not. Both Costantini and
84 C.A. No. 6793-VCG, 2013 WL 4041495 (Del. Ch. Aug. 8, 2013). 85 C.A. No. 8613-VCG, 2013 WL 4758228 (Del. Ch. Sept. 5, 2013). On September 13, 2013 Vice Chancellor Glasscock noted that the court had mistakenly overlooked Khan’s alternative argument that he was an agent of Swiss Farm. Because briefing and oral argument did not fully address this issue, the court requested additional submissions to be completed by September 25, 2013. Return to top
Delaware Quarterly Kahn sought indemnification for their litigation fees and expenses arising out of their successful defense of a breach of fiduciary duty claim brought by Swiss Farm. Defendants argued that the indemnification language contained in the Swiss Farm operating agreement, which incorporated, nearly word-for-word, the permissive indemnification provisions of Section 145 of the DGCL, required a showing of “good faith” for one to be entitled to indemnification in any circumstance. The court acknowledged that the operating agreement did incorporate the language from Section 145, the indemnification provision governing corporate actors. However, the court found that the indemnification provision in the operating agreement unambiguously allowed indemnification when a manager prevailed “on the merits or otherwise” regardless of good faith. Thus, Costantini was entitled to indemnification and no showing of good faith was required under the mandatory indemnification provision. However, as to Kahn, the court found that indemnification was not appropriate. Kahn had argued that because Swiss Farm had alleged that Kahn owed Swiss Farm fiduciary duties, Swiss Farm sued Kahn in the capacity of a manager. The court disagreed, finding that Swiss Farm alleged that Kahn participated in a managing member’s fiduciary breaches and made no claim that Khan owed fiduciary duties to Swiss Farm. Because the operating agreement only extended to members of the board of managers, officers, employees and agents of Swiss Farm, Kahn was not entitled to indemnification.
Appraisals
• In
Merion Capital, L.P. v. 3M Cogent, Inc.,86 Vice Chancellor Parsons determined the fair value of Cogent, Inc. (“Cogent”) in an appraisal action arising from the merger of Cogent with 3M Company (“3M”). Petitioners, who acquired stock in Cogent after the merger had been announced, rejected the $10.50 merger price and filed a petition for appraisal pursuant to Section 262 of the DGCL. Petitioners argued that the fair value of the company was $16.26 per share, relying on the DCF analysis of their expert. 3M argued that the fair value was $10.12 per share, relying on its expert’s DCF, comparable companies and comparable transactions analyses. The court rejected 3M’s expert’s comparable companies and comparable transactions analyses – finding a lack of sufficiently comparable companies and
86 C.A. No. 6247-VCP, 2013 WL 3793896 (Jul. 8, 2013).
Winston & Strawn LLP | 12 a lack of sufficient data points. The court then turned to the competing DCF analyses, considered their inputs and assumptions and performed its own calculation of the value of the company. Essentially relying on the model presented by 3M’s expert, the court determined the value to be $10.87 per share. The court also rejected 3M’s argument that the actual merger price was evidence of fair value, relying on the Delaware Supreme Court’s decision in Golden Telecom, Inc. v. Global GT LP, which held that Section 262(h) calls upon the Chancery Court to perform an independent evaluation of fair value – not defer to the merger price.87 In addition to an appraisal, petitioners also sought prejudgment interest. While the court recognized that an interest rate different than the statutory rate “may be justified where it is necessary to avoid an inequitable result,” the court rejected 3M’s argument that statutory interest should not be awarded to those who purchase stock after the announcement of the merger. The court, relying on Salomon Brothers, Inc. v. Interstate Bakeries Corp.,88 found that Delaware law did not disfavor such purchases.
Arbitration Awards
• In ENI Holdings, LLC v. KBR Group Holdings, LLC,
89
Vice Chancellor Glasscock, in a letter opinion, denied KBR Group Holdings, LLC’s (“KBR”) motion to enjoin arbitration proceedings to determine the working capital of Roberts and Shaefer Co. (“R&S”), a company that KBR sought to purchase from ENI Holdings, LLC (“ENI”). The dispute arose from the acquisition of R&S by KBR pursuant to a stock purchase agreement, which based the purchase price, in part, on the working capital of R&S. The agreement provided that any dispute relating to the determination of working capital must be submitted to binding arbitration. KBR sought to enjoin the arbitration proceeding, arguing that ENI might improperly assert that the court was bound to the arbitrator’s decision on working capital in considering the instant action – which involved indemnification claims. However, in its briefing, ENI made clear that the court would not be so bound. KBR also argued that the question of whether a revised arbitration notice was valid should be determined by the court, not by the
87 11 A.3d 214 (Del. 2010). 88 576 A.2d 650 (Del. Ch. 1989), appeal refused, 571 A.2d 787, 1990 WL 18152 (Del. 1990). 89 C.A. No. 8075, 2013 WL 4877916 (Del. Ch. Sept. 13, 2013). Return to top
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arbitrator. The court noted that the issues before it were largely mooted by the Delaware Supreme Court decision of Viacom International v. Winshall,90 which clarified that only questions regarding whether the subject of a dispute falls within the parameters of an arbitration agreement are appropriate for judicial decision. Because the arbitration would not preclude KBR’s ability to seek its indemnification claims, the court found that KBR did not show irreparable harm and denied KBR’s motion for preliminary injunction.
• In Viacom Int’l Inc. v. Winshall,
the Supreme Court affirmed the Chancery Court’s dismissal of Viacom’s challenge to an arbitration award. Viacom had argued that the arbitrator improperly refused to consider certain evidence and lacked authority to decide whether a particular issue was arbitrable. As part of a merger agreement, Viacom agreed to make earn-out payments to stockholders of the target corporation. The parties disagreed on the earn-out calculations and submitted their dispute to arbitration. The merger agreement and the engagement letter with the arbitrator restricted the arbitration to the issues presented in parties’ initial submissions. Certain inventory write-downs were not included in Viacom’s initial submissions, but Viacom nevertheless included them in a later submission. In determining the earn-out calculation, the arbitrator did not consider the inventory write-down deductions because: (i) they were not included in the parties’ initial submissions; and (ii) when asked, the parties would not agree to add the write-downs into the scope of the arbitration. On appeal, Viacom argued that the arbitrator’s refusal to consider the write-downs rendered the arbitration fundamentally unfair. The Supreme Court found that there was no misconduct on the part of the arbitrator and that the write-down issue could not be considered without consent of the parties. The Court also considered Viacom’s contention that the question of whether the write-downs could be arbitrated was one of substantive arbitrability that must be decided by a court. The Court disagreed and found that the write-down issue was one of procedural arbitrability and was properly decided by an arbitrator. In so doing, the court clarified certain other matters of procedural arbitrability, such as what financial or other information should be considered in the calculation of an earn-out, the amount of working capital, a company’s 91
90 C.A. No. 513, 72 A.3d 78 (Del. Supr. Jul. 16, 2013). 91 C.A. No. 513, 72 A.3d 78 (Del. Supr. Jul. 16, 2013).
net worth at closing, etc. – overruling some Chancery Court decisions to the contrary. Contract Interpretation
• In Shareholder Representative Services LLC v. ExlService
Holdings, Inc.,92 Vice Chancellor Glasscock, in a letter opinion, granted defendant ExclService Holdings, Inc.’s (“EXL”) motion to compel arbitration. EXL argued that because plaintiff Shareholder Representative Services’ (“SRS”) claims arose out of the merger agreement, the dispute must be resolved through arbitration according to the terms of the merger agreement. SRS argued that because it sought equitable relief in the form of an injunction, its claims fell under an exception to the mandatory arbitration clause of the agreement – which provided that an arbitrator “shall have no power or authority to grant injunctive relief, specific performance, or other equitable relief.” The court disagreed, finding that SRS’s claims were not equitable in nature, as SRS sought an injunction to enforce the terms of the contract and not to prevent irreparable harm. Thus, the court found that the arbitration carve-out did not apply and that the parties had clearly and unambiguously provided for an arbitrator to resolve all issues touching on contract rights and performance.
Books and Records
• In
Barnes v. Telestone Technologies Corp.,93 Vice Chancellor Glasscock, in a letter opinion, dismissed the complaint of a purported stockholder of defendant Telestone Technologies Corp. (“Telestone”) who had failed to comply with the requirements of 8 Del. C. § 220 in making his initial demand for the company’s books and records. Section 220 requires, among other things, that a stockholder who seeks to inspect a company’s books and records must provide documentary evidence of beneficial stock ownership. Plaintiff had failed to provide this evidence at the time that he sent his initial inspection demand to Telestone. Plaintiff argued that he satisfied the requirement by providing a sworn affidavit affirming his beneficial ownership at the time of his initial demand and by providing other evidence of his beneficial ownership in response to Telestone’s motion to dismiss, but the court disagreed. The court dismissed the Section 220 complaint, finding that “[s]trict adherence to
92 C.A. No. 8367-VCG, 2013 WL 4535651 (Del. Ch. Aug. 27, 2013). 93 C.A. No. 8513-VCG, 2013 WL 3480270 (Del. Ch. Jul. 10, 2013). Return to top
Delaware Quarterly the Section 220 procedural requirements for making an inspection demand protects the rights of the corporation to receive and consider a demand in proper form before litigation is initiated.” Relying on the Delaware Supreme Court’s decision in Central Laborers Pension Fund v. News Corp.,94 the court found that submission of a sworn affidavit and any supplemental documentation in litigation was insufficient to cure the original defect under Section 220.
Class Actions Fiduciary Duties
• In
Miramar Firefighters Pension Fund v. AboveNet, Inc.,95 Vice Chancellor Noble dismissed a class action complaint brought by a former AboveNet Inc. (“AboveNet”) stockholder alleging that the former directors of AboveNet breached their fiduciary duties in connection with the acquisition of AboveNet by Zayo Group, LLC (“Zayo”) and that Zayo aided and abetted such breaches. The court dismissed the claims that the directors breached their fiduciary duty of loyalty in connection with the acquisition process, because the complaint was conclusory and was “plainly insufficient” to allege that the directors were self-interested, not independent or acted in bad faith. Namely, there was insufficient evidence to allege: (i) that the directors had failed to obtain adequate consideration, as the merger represented a 21% premium over AboveNet’s average closing price for 60 days prior to the merger announcement; (ii) that the board excluded strategic buyers from the sale process in favor of private equity buyers, noting that the board ultimately approved a merger with a strategic buyer; and (iii) that the board had agreed to preclusive deal protection devices. The court found that the deal protection devices, including a termination fee of approximately 2% of the equity value of the deal and a no-solicitation restriction following the 30-day-go-shop, were reasonable. The court also dismissed the aiding and abetting claims against Zayo, because plaintiff did not establish that the directors had breached their fiduciary duties.
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Contracts Interpretation
• In Fiat North America LLC v. UAW Retiree Medical
Benefits Trust,96 Vice Chancellor Parsons, in a memorandum opinion, denied in part the parties’ cross-motions for judgment on the pleadings. Plaintiff, Fiat North America LLC (“Fiat”), sought specific performance for the delivery of stock pursuant to its exercise of a call option. The call option allowed Fiat to purchase stock of Chrysler Group LLC (“Chrysler”) from a health care trust that Chrysler had formed. The parties disagreed as to how to calculate the purchase price under a previously agreed to formula. While Fiat calculated the price to be $139.7 million, the health care trust calculated the price to be $343.1 million. At issue was whether the notes of the stock constituted “debt” of Fiat and whether income, attributable to non-controlling interests, should be included in Fiat’s EBITDA. Also at issue was whether certain provisions of an exemption issued by the Department of Labor, which granted Chrysler relief from provisions of ERISA that prohibited sales of property between an ERISA plan and parties in interest, had been met – if they had not, this would bar delivery of the requested shares. Interpreting the various agreements amongst the parties, the court found that Fiat’s argument that the notes constituted debt was proper. As for whether Fiat erred by including net income attributable to the plan’s non-controlling interest in EBITDA, the court concluded that it had not and that Fiat’s interpretation was the only reasonable one. However, the court disagreed with Fiat’s understanding of other terms of its call option agreement, and accordingly, denied Fiat’s request for specific performance. Finally, the court questioned whether it had subject matter jurisdiction over plaintiffs’ questions regarding the Department of Labor’s exemption. The court preliminarily concluded that it lacked subject matter to decide the question, because applicable federal regulations suggested that the issue should be addressed by the Department of Labor first.
• In
Medicis Pharmaceuticals Corp. v. Anacor Pharmaceuticals, Inc.,97 Vice Chancellor Parsons denied defendant Anacor Pharmaceutical’s (“Anacor”) motion to dismiss plaintiff Medicis Pharmaceutical Corporation’s (“Medicis”) claims, holding that they
94 45 A.3d 139 (Del. 2012). 95 C.A. No. 7376-VCN, 2013 WL 4033905 (Del. Ch. Jul. 31, 2013).
96 C.A. No. 7903-VCP, 2013 WL 3963684 (Del. Ch. Jul. 30, 2013). 97 C.A. No. 8095-VCP 2013 WL 4509652 (Del. Ch. Aug. 12, 2013). Return to top
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were not subject to mandatory arbitration under the parties’ license agreement. Medicis and Anacor entered into a license agreement, which contained a dispute resolution provision requiring that the parties arbitrate certain disputes and a carve-out provision providing each party with the right “to institute judicial proceedings . . . to enforce the instituting Party’s rights hereunder through specific performance, injunction, or similar equitable relief.” A dispute arose under the agreement and Anacor initiated arbitration. Medicis then filed its complaint seeking specific performance and injunctive relief relating to the alleged breach of the agreement. Anacor moved to dismiss the action for lack of subject matter jurisdiction, arguing that the parties were compelled to arbitrate the dispute under the dispute resolution provision. The court analyzed the carveout provision, specifically whether “hereunder” meant under the dispute resolution section of the agreement or under the entire agreement, concluding that “hereunder” was intended to mean “under the entire [a]greement” and thus created a broad exception to the mandatory arbitration provision. As such, the court concluded that it had subject matter jurisdiction over Medicis’ claims. The court noted that to hold otherwise would be to “ignore the plain and unambiguous language of the agreement negotiated by two sophisticated business entities.”
• In Recor Medical, Inc. v. Warnking,
Vice Chancellor Noble, in a post-trial memorandum, held that one of two patent applications filed by defendant had been acquired by plaintiff Recor Medical, Inc. (“Recor”) through its purchase of an insolvent medical device company, ProRhythm, Inc. (“ProRhythm”). Plaintiff sought a declaratory judgment that it owned the patents and sued defendants, former employees of ProRhythm, for breach of fiduciary duty. Defendant former CEO of ProRhythm had filed the patents thirty days after his employment ended. The court looked to the ProRhythm invention assignment agreement (governed by New York law) and the asset purchase agreement between Recor and ProRhythm (governed by Delaware law). Under the former, any “Proprietary Information” that defendant former CEO “conceive[d]” of during his employment at ProRhythm became an asset of ProRythm if it ‘relate[d]’ to the business of the company.” Because the court viewed this as a contract case, the court rejected defendant’s attempt to define “conceive” as it is used in 98
98 C.A. No. 7387-VCN, 2013 WL 3760022 (Del. Ch. Jul. 16, 2013) (revised opinion).
patent law, which would have imposed a higher standard of proof on plaintiff to show that defendant conceived of his inventions during his employment at ProRhythm. The court found that plaintiff had established by a preponderance of the evidence that defendant CEO had conceived of the idea for one of the patents while employed at ProRhythm and that this patent was an asset of ProRhythm. Accordingly, plaintiff Recor acquired it under the asset purchase agreement.
Corporate Governance Board Elections and Composition
• In
Canmore Consultants Ltd. v. L.O.M. Medical International Inc.,99 Vice Chancellor Glasscock denied plaintiffs’ petition to order a new election under 8 Del. C. § 223, under which stockholders owning at least 10% of a company may petition the court to order a stockholder vote to fill vacancies on the company’s board. Plaintiffs argued that by satisfying the standing requirements of Section 223(c), they were entitled to a presumption in favor of ordering an election. Having satisfied the standing requirements, plaintiffs argued that they were entitled to a new election or, at minimum, the equities construed in their favor. The court rejected this interpretation, and instead reasoned that under the permissive language of the statute, the court had discretion to weigh the equities based on the facts presented. It further found that Section 223(c) placed the burden upon the plaintiffs to demonstrate that the equities weigh in favor of ordering a new election. The court found that plaintiffs failed to meet this burden, primarily because the company lacked the necessary funds to hold another meeting and, as such, the equities did not favor forcing the cash-strapped company to repeat the same struggle for control.
• In
Red Oak Fund, L.P. v. Digirad Corp.,100 Vice Chancellor Noble, in a letter opinion, denied defendant Digirad Corp.’s (“Digirad”) motion to dismiss plaintiff Red Oak Fund, L.P.’s (“Red Oak”) complaint challenging the validity of a stockholder vote for control of Digirad’s board and seeking a new election under 8 Del. C. § 225. Red Oak alleged that Digirad had: (i) improperly induced stockholders to vote on the winning side; (ii) withheld negative financial information until voting had concluded; and (iii) failed to disclose its intent to adopt a poison pill. The court, noting that it must “draw all
99 C.A. 8645-VCG, 2013 WL 5274380 (Sept. 19, 2013) 100 C.A. No. 8559-VCN, 2013 WL 4014283 (Del. Ch. Aug. 5, 2013). Return to top
Delaware Quarterly reasonable inferences in favor of the plaintiff” in the context of a motion to dismiss, held that it “could not fairly conclude that it is not ‘reasonably conceivable’ that Red Oak could prevail at trial.”
Derivative Actions
• In Arkansas Teacher Retirement System v. Countrywide
Financial Corp.,101 the Delaware Supreme Court addressed a certified question from the United States Court of Appeals for the Ninth Circuit: “Whether, under the ‘fraud exception’ to Delaware’s continuous ownership rule, stockholder plaintiffs may maintain a derivative suit after a merger that divests them of their ownership interest in the corporation on whose behalf they sue by alleging that the merger at issue was necessitated by, and is inseparable from, the alleged fraud that is the subject of their derivative claims.” The question arose in the context of a shareholder derivative action brought by institutional investors of the former Countrywide Financial Corporation (“Countrywide”). While the derivative suit was pending, Countrywide and Bank of America Corporation merged, thereby divesting plaintiff investors of their Countrywide stock. The district court found that plaintiffs no longer met the “continuous ownership” requirement for shareholder derivative standing under either federal or Delaware law. Subsequently, the Supreme Court decided Arkansas Teacher Retirement Systems v. Caiafa,102 a related case, and found essentially that the “fraud exception” to the continuous ownership requirement was not currently supported by the record because the record did not reflect that the merger occurred solely to deprive stockholders of standing. However, the Supreme Court noted in dictum that the Caiafa plaintiffs could have, but had not, pled a claim for “a single, inseparable fraud” alleging that premerger fraudulent conduct necessarily gave rise to the merger. Latching onto this dictum, plaintiffs moved for reconsideration of the district court’s dismissal of their derivative claims and eventually appealed to the Ninth Circuit on the basis that the Supreme Court’s decision in Caiafa expanded the “fraud exception” to Delaware’s continuous ownership rule. In answering the certified question in the negative, the Supreme Court reaffirmed Lewis v. Anderson,103 which held that where a merger subsequently deprives a derivative plaintiff of her stock, the derivative claim brought on behalf of the acquired
101 C.A. No. 10-56340, 2013 WL 4805725 (Del. Sept. 10, 2013). 102 996 A.2d 321 (Del. 2010). 103 477 A.2d 1040 (Del. 1984).
Winston & Strawn LLP | 16 corporation is transferred to the acquiring corporation and the derivative plaintiff loses standing to maintain her derivative claim. The Supreme Court found that the merger unequivocally extinguished plaintiffs’ standing to pursue derivative claims and that its prior discussion of “inseparable fraud” referred to direct, not derivative claims.
• In In re China Automotive Systems, Inc.,
Vice Chancellor Noble dismissed with prejudice a shareholder derivative action alleging breaches of fiduciary duty against China Automotive Systems, Inc.’s (“China Automotive”) board for its purported failure to maintain adequate accounting controls and audit practices. According to plaintiffs, as a result of these alleged breaches, China Automotive made material misstatements in its public filings and was subsequently forced to issue restatements, causing its stock price to drop. Defendants moved to dismiss plaintiffs’ claims under Court of Chancery Rule 23.1 for failure to make a demand on the board or to establish, through particularized facts, that a demand would have been futile. The court, in granting defendants’ motion, noted that to demonstrate demand futility, plaintiffs were required to plead with particularity that the directors were acting in bad faith by systematically failing to exercise oversight. According to the court, plaintiffs’ complaint lacked allegations sufficient to make this showing. For instance, plaintiffs failed to allege particularized facts demonstrating that the directors had knowledge of accounting “red flags” or that the board’s audit committee was deficient or consciously disregarded its duties. 104
• In Joseph P. Ausikaitis v. Masimo Corp.,
the United States District Court for the District of Delaware denied defendants’ motion to dismiss a shareholder derivative action alleging that Masimo Corp.’s directors breached their fiduciary duties by opportunistically timing the grant of stock options to themselves and certain of the company’s officers in violation of various stockholderapproved compensation plans. Defendants sought dismissal on the ground that plaintiff had failed to make a pre-litigation demand on the board. The court, in denying defendants’ motion, held that plaintiff had sufficiently raised a reasonable doubt that the directors, who had allegedly benefitted from the challenged stock 105
104 C.A. No. 7145-VCN, 2013 WL 4672059 (Del. Ch. Aug. 30, 2013). Winston & Strawn represented defendant China Automotive Systems, Inc. in this case. 105 C.A. No. 12-1175-SLR, 2013 WL 3753983 (D. Del. Jul. 16, 2013). Return to top
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option grants, were disinterested. The court also rejected defendants’ argument that plaintiff’s claims were barred by the statute of limitations, finding that the company’s public disclosure of limited information concerning two of the stock option grants at issue was insufficient to demonstrate, at the motion to dismiss stage, that plaintiff was on inquiry notice of its claims at the time of the disclosure. Finally, the court rejected defendants’ assertion that plaintiff had failed to state a claim for breach of fiduciary duty, holding that plaintiff had alleged particularized facts giving rise to an inference that the company’s directors intentionally violated the compensation plans.
Expedited Proceedings
• In In re Dole Food Co., Inc. Stockholder Litigation,
106
Vice Chancellor Laster, in a transcript ruling, denied plaintiffs’ motion to expedite proceedings and to enjoin a merger pursuant to which David Murdock, Dole Food Company, Inc.’s (“Dole”) Chairman and Chief Executive Officer, acting through his affiliates, would acquire all of the outstanding shares of Dole common stock not currently held by him. The court first noted that in ruling on a motion to expedite, it must address two issues: (i) whether the complaint presents a colorable claim; and (ii) whether there is a threat of irreparable harm sufficient to warrant an expedited schedule and preliminary injunction hearing. The court found that although plaintiffs had a colorable underlying claim – there being “no question about that” – plaintiffs could not show a threat of irreparable injury justifying expedited proceedings. The court noted that pre-closing expedition of a case regularly occurs in the context of third-party deals where money damages cannot be awarded post-closing because there is “nobody who can pay.” However, in the instant case, the de facto controller was on the buy side and stockholders could litigate to obtain “real money for the class.” Even if preclusive deal measures were removed and a truly competitive goshop period was instituted, plaintiffs could still seek and obtain money damages post-closing. The court did not stay discovery and allowed the case to proceed in the ordinary course.
106 C.A. No. 8703-VCL (Del. Ch. Aug. 29, 2013). In another transcript ruling issued in the case that same day, the court appointed lead plaintiff and counsel.
Fiduciary Duties
• In In re Morton’s Restaurant Group, Inc. Shareholders
Litigation,107 Chancellor Strine granted defendants’ motion to dismiss an action seeking to block the sale of Morton’s Restaurant Group (“Morton’s”). Plaintiffs alleged that Morton’s private equity investor, Castle Harlan, which held 27.7% of Morton’s stock and had appointed two members to Morton’s board, had improperly pressured Morton’s board to enter into the transaction in order to obtain liquidity to support a new investment fund. According to plaintiffs, Castle Harlan was a controlling stockholder whose involvement subjected the transaction to heightened review. The court rejected this argument, holding that Castle Harlan’s 27.7% ownership, absent other allegations of control, was insufficient to demonstrate that Castle Harlan was a controlling stockholder. The court also noted that Castle Harlan stood to receive the same consideration in connection with the sale as all other stockholders. Accordingly, the court, applying the business judgment rule, concluded that defendants had not breached their fiduciary duties in connection with the sale.
Fraud
• In Universal Enterprise Group, L.P. v. Duncan Petroleum
Corp.,108 Vice Chancellor Laster, in a post-trial opinion, rejected plaintiffs’ claim that defendants committed fraud in connection with an asset purchase agreement. Plaintiff Universal Enterprise Group, L.P. and certain related entities (“Universal”) entered into an asset purchase agreement with defendant Duncan Petroleum Corp. (“Duncan”), pursuant to which Universal would acquire several gas stations from Duncan. Under the agreement, Universal had the right to a sixty-day post-signing due diligence period. The agreement also contained representations by Duncan that the gas stations were operated in compliance with all applicable industry and environmental regulations. During the post-signing due diligence period, Universal’s consultants discovered contamination at nearly all of the properties. Universal subsequently renegotiated the agreement to address these issues. After the transaction closed, Universal sued defendants for fraud and breach of the agreement based on Duncan’s false statements concerning its compliance with applicable regulations. The court rejected Universal’s fraud claim, holding that Universal failed to
107 C.A. No. 7122-CS, 2013 WL 4106655 (Del. Ch. Jul. 23, 2013). 108 C.A. No. 4948-VCL, 2013 WL 3353743 (Del. Ch. Jul. 1, 2013). Return to top
Delaware Quarterly demonstrate reliance on Duncan’s misrepresentations. According to the court, Universal viewed defendants’ representations regarding its compliance with applicable regulations with skepticism and relied on its own consultants during the due diligence process. The court did, however, find that defendants had breached the agreement. While Universal had sought diminutionin-value damages in connection with this breach, the court awarded only actual damages, which the court concluded placed Universal in the position for which it had bargained.
Winston & Strawn LLP | 18 over Investment Services, which created and maintained the books and records at issue in either Indiana or Florida. The court found that the fact that Investment Services entered into a contract with the Joint Venture was insufficient to subject it to personal jurisdiction in Delaware. Moreover, the court found that the complaint failed to allege that Investment Services materially participated in the management of the Joint Venture and therefore jurisdiction could not be established by virtue of Section 18-109(a)(ii) of the Limited Liability Company Act.
Indemnification
Practice and Procedure
• In
Laches
William R. Huff v. Longview Energy Co.,109 Vice Chancellor Strine, in a letter opinion, granted defendant Longview Energy Company’s (“Longview”) motion to dismiss an action for indemnification brought by two of its directors. A Texas court had entered judgment against the directors in a separate action for breach of fiduciary duty. The directors appealed that judgment and also sought indemnification from Longview, arguing that they were “successful” within the meaning of 8 Del. C. § 145(c), because plaintiffs in the Texas action had abandoned most of their claims against the directors prior to trial. The court rejected the directors’ interpretation of Delaware’s indemnification statute, holding that it is “well-settled” under Delaware law that “indemnification claims do not typically ripen until after the merits of an action have been decided, and all appeals have been resolved.”
Jurisdiction
• In Florida R&D Fund Investors, LLC v. Florida BOCA/
Deerfield R&D Investors, LLC,110 Vice Chancellor Noble, in a letter opinion, dismissed an action seeking books and records under 6 Del. C. § 18-305 for lack of personal jurisdiction over the asset management agent of a joint venture LLC. Plaintiff Florida R&D Fund Investors, LLC (“R&D”), a member of defendant Florida BOCA/Deerfield R&D Investors, LLC (the “Joint Venture”), sought two categories of books and records in the possession and control of defendant HDG Mansur Investment Services, Inc. (“Investment Services”), the manager of the Joint Venture’s assets and an Indiana corporation. The court held that it could not exercise personal jurisdiction under Delaware’s long-arm statute
109 C.A. No. 8453-CS, 2013 WL 4084077 (Del. Ch. Aug. 12, 2013). 110 C.A. No. 8400-VCN, 2013 WL 4734834 (Del Ch. Aug. 30, 2013).
• In In re Nine Systems Corp. Shareholders Litigation,
111
Vice Chancellor Noble granted in part defendants’ motion to dismiss plaintiffs’ claims for breach of fiduciary duty and fraud in connection with the acquisition of Nine Systems Corporation by Akamai Technologies. While defendants argued that the claims of one group of plaintiffs were barred by the three-year statute of limitations, the court found that because the claims were equitable in nature, the statute of limitations applied only by analogy to assist the court in determining whether the claims were barred by the equitable doctrine of laches. The court concluded that it could not, at the motion to dismiss stage, resolve whether these plaintiffs’ claims were barred by laches. The court did, however, determine that the claims of a second group of plaintiffs were barred by laches, noting that these plaintiffs had made statements demonstrating that they were on inquiry notice of their claims in 2005 and could have asserted them at that time.
• In In re Sirius XM Shareholder Litigation,
Chancellor Strine dismissed an action alleging breach of fiduciary duties as time-barred. The action was brought by stockholders of Sirius XM Radio (“Sirius”) in connection with a 2009 investment agreement under which Liberty Media Corporation (“Liberty Media”) provided Sirius with $530 million in exchange for preferred stock in Sirius that was convertible into a 40% common equity interest. Under the agreement, Liberty Media agreed to a three-year standstill provision prohibiting it from taking majority control of Sirius during that time period. However, once the standstill period expired, 112
111 C.A. No. 3940-VCN, 2013 WL 4013306 (Del. Ch. Jul. 31, 2013). 112 C.A. No. 78800-CS (Del. Ch. Sept. 27, 2013). Return to top
Delaware Quarterly the agreement specifically prevented the Sirius board from using a poison pill or other defensive measure to prevent a Liberty Media takeover. When the standstill period expired, Liberty Media began purchasing additional Sirius stock on the open market. Plaintiffs sued in 2012 – months after the three-year statute of limitations had passed – alleging that the Sirius board breached its fiduciary duties by adhering to the terms of the investment agreement and by failing to block Liberty Media’s takeover. Plaintiffs argued that their action was not time-barred, because it was based on actions taken by the Sirius board after the standstill period expired – specifically in connection with the board’s failure to adopt a poison pill. The court disagreed, noting that “under Delaware law, a plaintiff’s cause of action accrues at the moment of the wrongful act – not when the harmful effects of the act are felt,” and the court found that the allegations at issue related to the board’s adherence to the terms of the 2009 agreement.
• In
Levey v. Brownstone Asset Management, LP,113 the Delaware Supreme Court reversed the Court of Chancery’s grant of summary judgment dismissing plaintiff’s action, finding that the Court of Chancery had, by improperly applying the statute of limitations by analogy, erroneously concluded that plaintiff’s claims were barred by the doctrine of laches. According to the Supreme Court, the Court of Chancery failed to consider its holding in IAC/InterActiveCorp. v. O’Brien,114 which provided that under certain “unusual conditions or extraordinary circumstances,” it is improper to apply the statute of limitations by analogy when determining whether a plaintiff has unreasonably delayed in filing suit. The Supreme Court found that such circumstances existed in plaintiff’s case because his delay in filing suit was “attributable to a legal determination in another jurisdiction.” The Supreme Court also found that plaintiff’s claims should not have been dismissed because the statute of limitations had been equitably tolled.
Preemption
• In
Freedman v. Redstone,115 the Delaware District Court, in a matter of first impression, held that Internal Revenue Code (“I.R.C.”) § 162(m), which provides that performance-based compensation for certain high-
113 C.A. No. 5714, 2013 WL 4525770 (Del. Aug. 27, 2013). 114 26 A.3d 174, 178 (Del. 2011). 115 C.A. No. 12-1052-SLR, 2013 WL 3753426 (D. Del. Jul. 16, 2013).
Winston & Strawn LLP | 19 ranking executive officers is tax deductible only if it is awarded pursuant to a stockholder-approved plan, does not preempt Delaware corporate governance law allowing for classes of non-voting stock. Plaintiff, a holder of nonvoting shares of Viacom, Inc., sued the company and its directors, alleging that he was denied the right to vote on a performance-based executive compensation plan in violation of I.R.C. § 162(m). According to plaintiff, I.R.C. § 162(m) requires that all stockholders have a vote on the compensation plan, regardless of whether the company’s charter designates certain shares as nonvoting. The court disagreed, reasoning that plaintiff failed to demonstrate that Congress intended I.R.C. § 162(m) to “meddle in matters of corporate governance,” an area traditionally governed by state law. The court also dismissed plaintiff’s related breach of fiduciary duty claim against the company’s directors, finding that plaintiff had failed to make a pre-litigation demand on the board. The court rejected plaintiff’s argument that a demand would have been futile, noting that plaintiff did not allege a “clear and undisputed violation” of the company’s compensation plan. Reargument
• In Anvil Holding Corp., v. Iron Acquisition Co., Inc.,
116
Vice Chancellor Parsons, in a letter opinion, denied plaintiffs Iron Acquisition Company and Indigo Holding Company, Inc.’s motion to amend or alter the judgment as to the court’s dismissal with prejudice of their claim for bad faith breach of contract. The court had dismissed the bad faith breach of contract claim because it was duplicative of plaintiffs’ fraud claim. In their motion to amend or alter the judgment, plaintiffs argued that they should have been permitted to amend their complaint to add allegations distinguishing their bad faith breach of contract claim from their fraud claim. The court disagreed, finding that plaintiffs had a fair opportunity to amend the complaint prior to filing an answering brief in response to defendant’s motion to dismiss. The court noted that motions to amend or alter the judgment “are not the appropriate method for a party to raise new arguments that it failed to present in a timely way.”
Temporary Restraining Orders
• In Hayes v. Activision Blizzard, Inc.,
Vice Chancellor Laster, in a transcript ruling, issued a preliminary 117
116 C.A. No. 7975-VCP, 2013 WL 4447840 (Del. Ch. Aug. 16, 2013). 117 C.A. No. 8885-VCL (Del Ch. Sept. 18, 2013). Return to top
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injunction blocking plaintiff Activision Blizzard, Inc.’s (“Activision”) plan to buy back a majority of Vivendi SA’s stake in the company through a private stock sale. Plaintiff, an Activision stockholder, alleged that the proposed deal, valued at approximately $8 billion, should be subject to a stockholder vote. The court, applying the two-prong test for application of a preliminary junction, found that plaintiff had satisfied the first prong – reasonable probability of success on the merits – because Activision’s charter allocated disinterested stockholders the power to approve the transaction. The court further found that plaintiff had satisfied the second prong – balancing of the hardships – because, as a matter of law, the wrongful deprivation of voting rights constitutes “irreparable harm.”
• In Morgan Stanley Smith Barney, LLC v. Chahalis,
118
Vince Chancellor Noble, in a transcript ruling, granted Morgan Stanley Smith Barney LLC’s (“Morgan Stanley”) request for a temporary restraining order (“TRO”) to enjoin defendants, former members of a joint production team at Morgan Stanley, from soliciting Morgan Stanley clients other than those clients that defendants had originated. The court noted that a TRO is extraordinary relief requiring plaintiff to show a colorable claim, irreparable harm and a balancing of the equities in its favor. The court found that Morgan Stanley presented a colorable claim and that the continued solicitation of defendants’ clients would constitute irreparable harm, both in terms of lost revenue and in terms of lost business relationships and business development opportunities. The court found that the equities favored Morgan Stanley, because the TRO would be of short duration and be limited in scope. The court rejected defendants’ unclean hands argument, noting that a dispute about commission allocations did not impact the basic issue at stake in the case – under what terms defendants could leave Morgan Stanley.
Privileges
• In
In re Information Management Services, Inc. Derivative Litigation,119 Vice Chancellor Laster, in a case of first impression in Delaware, addressed whether officers and directors have a reasonable expectation of privacy with respect to communications from their work email accounts. Plaintiffs, two trusts that had invested in
118 C.A. No. 8834-VCN (Del Ch. Aug. 29, 2013). 119 Consol. C.A. No. 8168-VCL, 2013 WL 4772670 (Del. Ch. Sept. 5, 2013).
Information Management Services, Inc. (“IMS”), moved to compel production of emails sent by defendants, executives of IMS, to their personal lawyers through their work email accounts. Defendants argued that the attorney-client privilege protected these emails from disclosure. The court, applying the test set forth in In re Asia Global Crossing, Ltd.,120 concluded that defendants did not have a reasonable expectation of privacy with respect to the emails because, among other reasons, the company’s policy, of which defendants were aware, expressly provided that employee emails are “open to access by IMS staff.”
• In In re Quest Software Inc. Shareholders Litigation,
121
Vice Chancellor Glasscock, in a letter opinion, rejected plaintiffs’ motion to compel defendants to produce attorney-client communications in an action seeking to enjoin a proposed management buyout of stockholders’ interests in Quest Software Inc. (“Quest”). Plaintiffs brought the action during the “go-shop” period. During the go-shop period, Dell, Inc. offered to merge with Quest, and Quest’s board ultimately accepted this offer. Consequently, plaintiffs filed a motion seeking attorneys’ fees under the corporate benefit doctrine. To help support their corporate benefit claim, based on allegations that the litigation induced Quest to accept Dell’s offer, plaintiffs sought certain communications between defendants and their attorneys. According to plaintiffs, defendants put these communications “at issue” by arguing that their “attorneys kept them informed of the status of the [l]itigation, but that the [l]itigation did not influence their negotiation of the Dell merger.” The court, in denying plaintiffs’ motion to compel the production of these communications, noted that the “at issue” exception to the attorney-client privilege arises only where a party raises an issue that can only be resolved by examining confidential communications. According to the court, defendants’ assertion that “no communication from counsel affected their actions with respect to the Dell merger” was not the “equivalent of a reliance on the advice of counsel that put the substance of the communication at issue in this litigation.”
120 322 B.R. 247 (Bankr. S.D.N.Y. 2005). 121 C.A. No. 7357-VCG, 2013 WL 3356034 (Del. Ch. Jul. 3, 2013). Return to top
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Settlement Proceedings
• In
In re Coventry Health Care Inc., Shareholders Litigation,122 Chancellor Strine, in a transcript opinion, approved the settlement of a consolidated class action related to the acquisition of Coventry Health Care, Inc. (“Coventry”) by Aetna, Inc. (“Aetna”). Shortly following the announcement of the merger, several class action complaints were filed in the Circuit Court for Montgomery County, Maryland and in the Delaware Court of Chancery against Coventry’s board of directors, Coventry, and Aetna, alleging, among other things, breach of fiduciary duty based on various disclosure deficiencies and unfair merger consideration and terms. The parties’ settlement of the consolidated Delaware actions included: (i) certain supplemental disclosures relating to the merger; (ii) a reduction in the termination fee of the merger agreement from $167.5 million to $100 million; and (iii) a reduction in the period during which Coventry was required to discuss and negotiate in good faith with Aetna before making recommendation against the merger. The court certified the class as a non-opt-out class and approved the settlement as fair in consideration of the strength of plaintiffs’ claims. However, the court took issue with plaintiffs’ counsel’s request for $1.9 million in attorneys’ fees. In assessing the reasonableness of the request, the court noted that marginal reductions in deal protections do not justify large fees and that it would be difficult to assess the benefit of the disclosures. Ultimately, the court found that the reduction in deal protection measures, modest disclosures, and limited contingent risk of the case warranted a fee award of $975,000.
122 C.A. No. 7905-CS (Del. Ch. Aug. 29, 2013). Return to top
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This Quarter’s Authors Jonathan W. Miller and Matthew L. DiRisio are partners, and Corinne D. Levy, Jill K. Freedman, Ian C. Eisner, Anthony J. Ford, Lee A. Pepper, Allison G. Castillo and Shawn R. Obi are associates, in the Litigation Department of Winston & Strawn LLP, resident in the Firm’s New York, Chicago and Los Angeles offices.
The Delaware Quarterly Advisory Board Chicago Ronald S. Betman Oscar A. David William C. O’Neil Robert Y. Sperling
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