Duane Morris Delaware Business Law

November 7, 2024November 7, 2024 by Richard L. Renck

PRECISION IN DRAFTING–PART DEUX

A new decision of Delaware’s Court of Chancery addresses an interesting intersection of recent attention to entities potentially moving their places of incorporation from Delaware to some other jurisdiction–like Nevada–and 2022 amendments to Section 266 of the DGCL that changed the historic need for a unanimous stockholder vote to enact such a conversion to the need to seek and receive only the vote of a simple majority of the shares entitled to vote (matching the voting requirements for a merger or consolidation under Section 251 of the DGCL).

Last week on this blog I wrote about a new Court of Chancery decision demonstrating the need for precision in drafting LLC agreements–specifically in how those agreements might address information rights of LLC Members. Yesterday, in Gunderson v. The Trade Desk, Inc., et al. (C.A. No. 2024-1029-PAF)(Nov. 6, 2024), the court makes the same point, but in this instance it makes clear that need for precision applies to provisions in a certificate of incorporation that provide for supermajority voting rights by stockholders in voting on certain types of corporate events or questions. Here, the court finds, applying Delaware’s venerable “doctrine of independent legal significance,” that where a certificate of incorporation does not clearly provide that supermajority voting rights apply for a conversion of the entity (pursuant to DGCL Sec. 266) from a Delaware corporation to a Nevada corporation, the simple majority voting provision set by the statue applies.

The stockholder plaintiff in this litigation argued that a conversion from a Delaware entity to a Nevada entity necessarily would trigger a provision in the certificate of incorporation that required a supermajority vote for actions that would “amend or repeal, or adopt any provision of this Restated Certificate inconsistent with” certain “Protected Provisions” of that certificate. The defendants argued that the supermajority voting rights applied “only to action taken under Section 242 of the DGCL, which specifically applies to certificate amendments,” and therefore the proper lens through which to review this conversion was Section 266 of the DGCL governing such conversions–including Section 266(b)’s default provision that such a conversion could be approved by a simple majority vote.

The court adopted the position of the defendants by applying the doctrine of independent legal significance. That doctrine “holds that legal action authorized under one section of the corporation law is not invalid because it causes a result that would not be achievable through other action under other provisions of the statute.” As the court noted:

The doctrine of independent legal significance is a bedrock of Delaware corporate law and should not easily be displaced. An open-ended inquiry into substantively equivalent outcomes, devoid of attention to the formal means by which they are reached, is inconsistent with the manner in which Delaware law approaches issues of transactional validity and compliance with the applicable business entity statue and operative entity documents (internal quotations omitted).

The court discussed at length how the courts of Delaware, for over 20 years, have made clear in a number of opinions that drafters wanting to alter statutory default voting provisions (whether in count or by class) must use clear and direct language telegraphing that intent. Historically, those cases involved questions of whether to extend charter-based voting requirements to mergers and consolidations (governed by Section 251 of the DGCL). The court also highlights: “[T]he entire field of corporation law has largely to do with formality. Corporations come into existence and are accorded their characteristics, including most importantly limited liability because of formal acts. Formality has significant utility for business planners and investors.”

The court concludes its discussion with this admonition:

The court’s goal here is to give effect to the drafter’s decisions in selecting which words to use–and which words not to use. Where decades of case law provides express guidance to corporate drafters and emphasizes that our courts charge drafters with knowledge of that case law, giving effect to the drafters’ decisions entails adhering to that guidance at the judicial level as well.

So for all the transactional counsel out there to whom the closing remarks are directed, this case makes clear two things. First, if the parties intend to apply a supermajority voting provision to a corporate act where the statute provides only for a majority vote, make that intent clear by specifically enumerating that act (ideally by mentioning the sections of the statute that are being altered). Second, I should make a shameless plug for this Delaware Business Law Blog where we report on new authority coming out of the Delaware courts, so please subscribe below to stay informed about the new case law as it comes out!

October 29, 2024October 29, 2024 by Richard L. Renck

Precision in Drafting–Information Rights of Members of LLCs

A recent order from the Court of Chancery highlights the need for precision in the drafting of LLC operating agreements, particularly in setting forth the rights that members of the LLC will have to information regarding the LLC. On August 21, 2024, Vice Chancellor Fioravanti issued his Order Addressing Motions to Dismiss in the matter of Potts, et al. v. SYFS Intermediate Holdings, LLC, et al., C.A. No. 2023-0557-PAF (copy below).

Plaintiffs in this action held Class B membership units in the LLC. One of their claims was that the LLC had breached the terms of the LLC operating agreement by failing to provide to them annual, audited financial statements for each fiscal year. It making their claim, the plaintiffs pointed to a provision in the operating agreement providing:

The Company will retain the Auditors to review, audit and report to the Members upon the financial statements of the Company for and as of the end of each Fiscal Year. The Auditors may be replaced or new auditors may be appointed at the discretion of the Board.

The Plaintiffs argued that the phrase “report to the Members” in this section created an obligation on the part of the LLC to send or provide copies of such audited financial statements to them as members of the LLC.

The Court of Chancery disagreed and dismissed this claim. It did so for two reasons.

First, the Vice Chancellor noted that one of the authorities that Plaintiffs relied upon did not support their position, as the limited partnership agreement at issue in that case provided that the general partner “shall prepare annual financial statements of the Partnership, and shall mail a copy of such statements to each Partner” (emphasis added) and that such statements were to be provided within 120 days of the end of the fiscal year. The court found that level of specificity trumped the less declarative “report to the members” language in the LLC agreement in the instant case.

Second, the Vice Chancellor pointed to a different provision of the LLC Agreement that did, indeed, provide specifically that certain audited financial statements were to be provided to certain members of the LLC:

The Company shall provide a copy of the most recent quarterly and audited annual financial statements of the Company to (i) each Class A Member, (ii) each Material SYFS Holder, so long as such Member continues to hold at least 50% of the Units held by such Member as of the date hereof, and (ii) [sic] so long as GPAC continues to hold at least 25% of the Units held by GPAC as of the date hereof, GPAC, in each case upon such Member’s request.

The Court of Chancery held that this section granted specific, but limited rights to information to the types of members noted. Given that Plaintiffs were neither the holders of the specified units noted in this section, nor had they made a request for the information, they could not look to the LLC agreement for contractual rights to LLC information.

That said, because the LLC Agreement was completely silent as to specific information rights that holders of Series B membership units might enforce, the Court of Chancery highligted that holders of those units could still resort to the default information rights as provided for in Section 18-305 of Delaware’s LLC Act.

As this Order demonstrates, counsel for both LLCs and their investors should be precise in their drafting to ensure that any rights to information in the LLC, whether specifically delineated or relegated to the statutory defaults, accurately reflect the intent of the parties to these agreements.

SYFS Opinion for Blog Post Download

September 30, 2024October 1, 2024 by Duane Morris

No Commercially Reasonable Efforts to Achieve Earnout Milestone in Pharma Merger

By Rebecca Guzman and Brandon Harper

In the second of its kind in as many days, the Court of Chancery issued a post-trial opinion enforcing contingent value rights or earnout provisions in merger agreements against breaching acquirors. In a September 5, 2024, opinion in Shareholder Representatives LLC v. Alexion Pharmaceuticals, Inc., the Court found that the buyer, Alexion Pharmaceuticals, Inc. (“Alexion”), a subsidiary of AstraZeneca, owed $130 million to the seller shareholders of Syntimmune, Inc. (“Syntimmune”) for a missed earnout milestone payment in its acquisition of the drug developer.

Following a seven-day trial, the Court held that Alexion was liable to Syntimmune shareholders for the earnout payment for achieving the first of eight total milestones and failing to use commercially reasonable efforts when it halted drug development.

The case is based on a 2018 merger agreement pursuant to which Alexion acquired Syntimmune for $1.2 billion. $400 million of the total price was due and paid at closing, while $800 million was due in increments upon completion of each of eight milestones agreed to by the parties related to the development of a monoclonal antibody to treat autoimmune diseases.

At issue in the case was the first milestone, which provided for a $130 million payment upon the successful completion of a Phase 1 clinical trial. Syntimmune’s stockholders argued that the criteria for that milestone were met, and that Alexion was in breach by failing to make the required earnout payment. Separately, Syntimmune’s stockholders argued that Alexion failed to use commercially reasonable efforts to achieve each of the remaining milestones after closing.

In response, Alexion argued that the drug development process was rife with challenges and the criteria for the first milestone had not been met. Alexion was forced to pause clinical trials in early 2020 when supply was contaminated and again during the COVID-19 pandemic. Alexion took the position that that the drug never reached “successful completion” of a Phase 1 clinical trial and, as a result, the first milestone was not met.

The Court ruled in favor of the plaintiff shareholders. The Court found that all conditions that needed to be satisfied for the first milestone had been met and awarded Plaintiffs $130 million. The Court’s decision was largely based on a determination on the satisfaction of the applicable criteria necessary to achieve the milestone. The Court ultimately found that the language and criteria set forth in the merger agreement related to achievement of the milestone was ambiguous and therefore the Court looked to extrinsic evidence.

In its commercially reasonable efforts analysis, the Court found that the parties agreed to an outward-facing, objective standard under and pursuant to the language set forth in, the merger agreement. The Court determined that the commercially reasonable efforts clause required that Alexion expend the efforts and considerations a hypothetical typical company similarly situated would have expended in developing a similar product. This “hypothetical company approach” is one of two ways of giving meaning to language in a commercially reasonable efforts clause. The other way is the “yardstick approach” in which commercially reasonable efforts are compared to the efforts of a similarly situated company in the same industry and their actions in the real world.

The Court observed that the outward-facing standard prohibited Alexion from considering its own self-interest in determining what is commercially reasonable. While the Court held that under the agreed upon standard Alexion need not undertake efforts that would be contrary to prudent business judgment, the decision on the part of Alexion to halt clinical development, given that it was driven largely by a broader corporate initiative of Alexion unrelated to the drug at issue, fell short of the “hypothetical company” commercially reasonable efforts standard agreed to between the parties in the merger agreement.

This case comes shortly after another earnout decision in which the Court of Chancery awarded damages to plaintiffs. In Fortis Advisors, LLC v. Johnson & Johnson et al., C.A. No. 2020-0881-LWW, the Court found Johnson & Johnson found liable for $1 billion for milestone payments related to the development of a surgical robot.

Ultimately these cases are another reminder to contract drafting practitioners (and their clients) to ensure that the liabilities and obligations set forth in a merger agreement reflect as closely as possible the commercial arrangement and intent of the contracting parties.

In addition, when parties negotiate and agree to efforts standards, they ought to consider how the liabilities and obligations under the specified transaction agreement fit within the overall framework of their business operations and key objectives (and ensure that the commercial agreement takes into account the broader business operations and key objectives).

September 3, 2024 by Richard L. Renck

“Stockholder List” and “Stock Ledger”–the same thing? Not under Delaware law.

I have a confession. I know there have been times in my twenty-five years in practice as a Delaware lawyer where I have lapsed or gotten lazy and used the terms “stockholder list” (or “stocklist” for short) and “stock ledger” interchangeably. A short, letter decision by Chancellor McCormick ruling on motions for summary judgment in the matter of Mitchell Partners, L.P. v. AMFI Corp., et al., C.A. No. 2020-0985-KSJM (July 3, 2024) provides a crisp reminder–both to me and to other professionals advising Delaware corporations–that they are not the same thing given the clear language of Section 219(c) of the DGCL.

The letter decision is a quick-read at eight pages, so I commend it to the reader in its entirety. That said, three lessons emerge from this decision.

First, Section 219(c) is specific in its command that a Delaware corporation keep a stock ledger and enumerates the small list of information required to be including on the ledger. The Chancellor quotes from a 1956 decision of the Delaware Supreme Court noting that a stock ledger is “a continuing record of stockholdings, reflecting entries drawn from the transfer books, and including (in modern times) nonvoting as well as voting stock.”

That leads directly to the second lesson: the Chancellor notes that the stock ledger must record “all issuances and transfers of stock of the corporation” (emphasis in original). This includes non-voting shares of stock. The stock ledger in the matter being decided was found deficient because it excluded a class of stock that had been issued but was nonvoting in nature.

Finally, the third lesson–what information must a company record on a compliant stock ledger? The court, in a footnote, provides guidance to practitioners from a variety of sources, whose lists of required information differ slightly. That said, the following types of data should be recorded by corporations on their stock ledger: (1) the stock certificate number, (2) the name of the stockholder, (3) the stockholder’s full address, (4) the class of shares, (5) the date of purchase or transfer, and (6) the price or value of the shares. Other types of information that might be considered for inclusion are: the date shares were cancelled, and the date the board approved the stock issuance.

Given the court’s citation to an opinion from 1956, this does not appear to be an issue that has resulted in litigation with any frequency. But with the issuance of this letter decision, the matter is likely now front and center with stockholders (and their counsel) as a potential source for litigation going forward. Thus, this decision is a perfect catalyst for Delaware corporations, and those that advise them on a regular basis, to dust off the ol’ ledger and make sure it is up to snuff!

August 9, 2024August 26, 2024 by Michael Gonen

Breaching on Purpose: What to Do About “Willful Breach”

One of the hallmarks of contract law is that it is not fault-based. A court, and especially a ‘contractarian’ Delaware court, only looks at whether a party performed the duties the contract imposes, not why. If parties want to be able to excuse performance for the ‘right’ reasons, or to trigger extra protections against breach for the ‘wrong’ reasons – that is, if they want to depart from the default no-fault analysis – then they need to write those reasons into the contract language itself. In the recent XRI Investment Holdings, LLC v. Holifield decision, the Court of Chancery examined a contract that did just that, containing provisions triggered by a finding of “willful breach,” but left that term undefined. Thus, the Court had to answer the question: what is a “willful breach” of contract?

In XRI, an LLC’s operating agreement required the LLC to advance legal fees to its members for LLC-related litigation, but allowed the LLC to recoup those fees if the litigation found the member had acted with “gross negligence or willful breach” of the LLC operating agreement. In the litigation, the LLC sued a member to challenge the putative transfer of the member’s membership interest in the LLC to an entity he controlled. In accordance with the agreement, the LLC advanced the member’s legal fees to defend against the LLC’s suit against him. The LLC prevailed in a 2022 decision that found the transfer breached the LLC’s operating agreement and was void, a finding the Delaware Supreme Court affirmed in an opinion last year. In these post-remand proceedings, the LLC sought to recoup those previously-advanced legal fees under the argument that the member’s attempt to transfer his membership interest had “willfully breached” the LLC operating agreement.

As the Court explained, clauses specifying remedies for “willful” breach are common in commercial contracts, especially in merger agreements, but more often than not, the commercial contracts themselves do not supply a definition of “willful breach.” In addition, despite the frequency of undefined “willful breach” clauses, no prior Delaware decision provided a default definition. Scholarly sources the Court examined suggest three different possible measures of when a breach of contract becomes ‘willful.’

Under the most expansive standard, a breach is ‘willful’ if the breaching party simply did the breaching act on purpose. A middle definition further requires the breaching party to subjectively understand at the time that the act violated the contract. A narrow definition requires a further showing that the breaching party acted with malice.

The XRI decision does not identify a one-size-fits-all definition of willful breach. But in evaluating the facts of this case, since “willful breach” followed “gross negligence” in the same sentence of the operating agreement, the Court construed such placement as embodying a meaning that goes beyond mere voluntary action, in line with the middle definition. At least in the context of “gross negligence and willful breach,” conduct must be undertaken in subjective cognizance that it is a breach in order to be “willful.” Since the Court also found that the member had known the LLC operating agreement prohibited the transfer and did it anyway, the court held that the breach was willful under that standard and ordered the member to repay the LLC for his litigation costs, which were in the millions.

The Court’s decision has consequences well beyond the relatively niche world of advancement-recoupment actions. Because protections against “willful breach” occur so frequently in merger agreements without a contractual definition of the term (in the decision, the Court noted that in a study of over 1,000 merger and acquisition agreements while “a majority tie damages to a concept of willful breach, less than one third of public deals, and under one tenth of private deals, define the term”), the default rules supplied by Delaware case law may prove significant in cases involving mergers and acquisitions, which are among the marquee subject areas of Delaware litigation.

Moreover, recent amendments to the Delaware General Corporate Law (“DGCL”), which we have previously discussed outside this blog, have added an additional dimension of importance. As previously discussed, the amendments authorize the inclusion of corporate governance provisions in stockholder agreements, but the outer bounds of inclusion of such provisions remains unknown. The DGCL amendments have already set off a flurry of discussion among practitioners and scholars over what happens when such a stockholder agreement requires a corporate fiduciary to act one way while their fiduciary duties command the opposite. If a fiduciary, in the face of such contradictory duties, prioritizes the fiduciary duty over the contractual one, is that breach “willful”? With the court’s answer to that question unknown, parties may want to consider addressing it themselves through an express provision in the contract for added clarity.

Finally, with “willful breach” terms so common in the context of mergers & acquisitions agreements, XRI v. Holifield demonstrates the prudence of parties setting out an express definition within the body of their agreements to ensure the parties have clarity on its meaning.

August 7, 2024 by Duane Morris

The 2024 Delaware General Corporation Law Amendments Are Effective August 1

Several amendments to the Delaware General Corporation Law (DGCL), articulated in Delaware Senate Bill 313 (SB 313), have been adopted by the Delaware General Assembly and signed into law by Governor John Carney. These amendments will take effect on August 1, 2024, and will apply retroactively to all contracts and agreements (including merger and consolidation agreements) made by a Delaware corporation and all contracts, agreements and documents approved by the board of directors of a Delaware corporation. We explore these amendments further below.

Read the full Alert on the Duane Morris LLP website.

July 19, 2024July 19, 2024 by Michael Gonen

Supreme Court Clarifies Treatment of Valid But Unfair Corporate Rules

Last week, the Delaware Supreme Court handed down a decision in Kellner v. AIM Immunotech, Inc., partially reversing a decision from the Court of Chancery this past December. The opinion gives color to an important topic in Delaware corporate law: when a corporate board adopts bylaws into the corporation’s constitutive contract which are valid in the abstract, but does so in an inequitable manner, how should a court remedy the unfairness?

Kellner related to a long-running effort by a group of dissident stockholders to get allies elected to the corporation’s board. In this latest litigation, the stockholders challenged recently-enacted corporate bylaws which the incumbent board used to block their nomination of candidates.

As we have previously discussed on this blog in relation to the Coster v. UIP Companies case last year, Delaware courts describe fiduciary conduct as “twice-tested,” first for legal authority, and second for equity.

For legal authority, the Court found that all but one of the bylaws passed. Each was directed to important goals of disclosure and transparency in corporate elections. Had they been enacted on a clear day — meaning, in the absence of a dissident group of stockholders trying to unseat the incumbent board — there was nothing wrong with them. But, at the second step, deferring to the trial court’s factual findings, the Court found that the board had crafted the bylaws for the improper purpose of de facto preventing stockholders from voting in a contested election at all.

The Court explains the correct remedy following from that structure of analysis: the bylaws were successfully adopted and incorporated into the corporate contract, but should not have been applied to the dissidents in the specific election at issue.

With the recent amendments to the Delaware General Corporate Law permitting internal corporate affairs ordinarily contained in the corporate constitutive contract — the charter and bylaws — to be addressed by stockholders’ agreements, this framework of analysis may see frequent use in the coming years.

April 24, 2024 by Richard L. Renck

Weinberg Center for Corporate Governance holds its 2024 Distinguished Speaker and Panel

The John L. Weinberg Center for Corporate Governance of the University of Delaware recently put on a great program with two very timely and important presentations. One on how companies and their boards can navigate the turbulent waters surrounding calls for the entity to speak out on cultural and other “hot button” topics–some of which may be directly related to the business of that entity–some not. And second, a very lively panel discussion of the modern day use of special litigation committees to review derivative claims and litigation. Links to videos and other materials from this fantastic presentation may be accessed here.

April 19, 2024 by Richard L. Renck

How Do the New Texas Business Courts Stack up to Delaware’s Court of Chancery?

There has been much in the news recently about whether Delaware’s preeminence in the world of corporations and alternative entities is being materially challenged by other states–such as Texas or Nevada. Recently, Texas armed its challenge with the passing of legislation creating a new system of business courts designed to better address the needs of sophisticated, commercial litigants.

The Spring 2024 edition of The Advocate, the journal of the Litigation Section of the Texas Bar Association, contains a series of articles on many aspects of the new Texas business courts, including support for and challenges facing that legislation and the courts it created. My colleague (Mackenzie Wrobel) and I contributed an article titled: “Lessons Learned: What Can the New Texas Business Courts Learn from the Experience of Its Sister States.?” In that article we discuss how states such as Delaware, North Carolina, Georgia and Wyoming have approached the tasks of creating business courts that foster the stability and predictability that sophisticated commercial litigants seek in submitting their disputes to such tribunals.

It will be interesting to watch how Texas navigates the same ground as some of her sister states. Stay tuned.

April 8, 2024 by Richard L. Renck

Delaware Supreme Court Gives Additional Guidance on Scope and Mechanics for Applying MFW Framework to Conflict Transactions

Recently, the Delaware Supreme Court issued its much-anticipated decision in In re Match Group, Inc. Derivative Litigation, No. 368, 2022 (April 4, 2024), in which the Court reaffirmed certain venerable teachings on the standards of review that the Delaware courts will employ to review challenged transactions involving a controlling stockholder—including when and how controlling stockholders can deploy the “MFW framework” (from Kahn v. M&F Worldwide Corp, 88 A.3d 635 (Del. 2014) (“MFW”)) to shift the standard of review from “entire fairness” to “business judgement.” In general, the MFW framework reflects the Supreme Court’s ruling in that case that where a controlling stockholder conditions a going-private transaction (which would normally be reviewed under the exacting entire fairness standard), from the beginning, on (1) approval by a fully-functioning independent committee of directors and (2) a fully-informed vote of the unaffiliated minority stockholders, the Delaware courts will look to see if that transaction was within the business judgment of the fiduciaries presenting and approving it.

Since the ruling in MFW in 2014, transactional planners, stockholder plaintiffs, and corporate defendants have all probed the contours of the ruling in various ways. For instance, can the MFW framework be deployed outside a squeeze-out merger context or does the entirety of the special committee need to be independent and disinterested or can just a majority of the members of the committee be satisfactory?

In the Match opinion, the Supreme Court discusses in detail (1) the historical framework of the various standards of review that the Delaware courts will use to review challenged corporate transactions and conduct, (2) the history behind, and the nature of, the Court’s ruling in MFW, and (3) additional guidance for corporate constituencies (including controlling stockholders, boards of directors, and their advisors) on the scope of and mechanics for properly deploying the MFW framework to shift the standard of review from entire fairness to business judgment. Specifically, the Supreme Court held:

Long-standing precedent holds that “in a suit claiming a controlling stockholder stood on both sides of a transaction with the controlled corporation and received a non-ratable benefit, entire fairness is the presumptive standard of review”—this is not limited to going-private mergers, but rather applies to all transactions with a controlling stockholder that would historically have been reviewed for entire fairness.
A “controlling stockholder can shift the burden of proof [to prove the transaction was not entirely fair] to the plaintiff by properly employing a special committee or an unaffiliated stockholder vote” (emphasis added). However, “the use of just one of these procedural devices does not change the standard of review” from entire fairness to business judgment.
If “the controlling stockholder wants to secure the benefits of business judgment review, it must follow all [of] MFW’s requirements.” That is, the transaction must be conditioned on both the approval by an effective and independent special committee, and the informed vote of approval by the unaffiliated stockholders.
For the special committee to be effective in “replicat[ing] arm’s length bargaining, all [special] committee members must be independent of the controlling stockholder.”