“Fraud in the Inducement” Is No Defense To Advancement Claims By Officers and Directors

On November 28, 2016, the Supreme Court of Delaware confirmed what had become a common thread in several previous decisions by the Court of Chancery–that a Delaware entity cannot avoid expansive advancement rights it has granted to its officers and directors by arguing that they had fraudulently induced the company to grant those rights.  In Trascent Mgm’t Consulting, LLC v. Bouri, No. 126, 2016 (Del. Supr.), the Supreme Court held that such a challenge to an officer’s right to advancement of fees and expenses for litigation was more properly heard during later proceedings to determine whether the officer was ultimately entitled to a right to indemnification upon the close of the underlying proceedings.

Trascent had hired Mr. Bouri as an officer and manager of the LLC with responsibility for the human resources, IT, and finance functions.  Mr. Bouri was employed pursuant to an employment agreement, which among other things, granted him broad rights to advancement of any fees and expenses he incurred in certain types of proceedings.  Trascent and Mr. Bouri parted ways, and Trascent sued Mr. Bouri for, among other things, breaches of his employment agreement.  Pointing to the terms of that employment agreement, Mr. Bouri sought advancement of his fees and expenses for defending against his former employer’s claims.  Trascent, however, argued that the same agreement upon which its claims were founded was induced by fraud, and therefore, Mr. Bouri’s claims for advancement should be denied.

The Court of Chancery rejected this defense, and the Supreme Court (with Chief Justice Strine writing for the court) affirmed that ruling.  As the Supreme Court noted:  “[A]llowing Trascent to avoid its contractual duty to make immediate advancement payments by making a belated fraudulent inducement claim would impede the efficiency of the summary mechanism provided by 8 Del. C. 145(k) and impair the public policies served by contractual advancement provisions made in reliance upon that provision of the DGCL as well as the Limited Liability Company Act,” and therefore “the Court of Chancery properly refused to delay enforcing the plain language of the contract.”

The Supreme Court, in a footnote, also noted that the reasoning and public policy supporting this ruling was equally applicable to agreements to arbitrate disputes–another area where the Court found these fraudulent inducement arguments to reflect “unproductive gamesmanship.” The court warned that parties should make such arguments to the arbitrator in the first instance and not a court in trying to avoid the contractual choice of venue for dispute resolution.

How Emails Between Counsel Can Bind Their Clients To ADR

The Court of Chancery of the State of Delaware recently issued a Memorandum Opinion finding that feuding members of a Delaware limited liability company had validly entered into an agreement to mediate, and if necessary arbitrate, their dispute where their respective counsel had engaged in an email exchange the court found to contain the elements of a binding agreement.

In Gomes v. Karnell, et al., C.A. No. 11814-VCMR (Del. Ch. Nov. 30, 2016), Vice Chancellor Montgomery-Reeves held she did not have subject matter jurisdiction to hear certain aspects of the dispute because she held that the parties were bound by the representations of their attorneys and rejected plaintiff’s arguments that no agreement could exist because it was missing essential terms.  While recognizing that there is no consensus among courts regarding what constitute the “essential terms” of an agreement to arbitrate, she found that the email exchange contained (i) evidence of assent; (ii) identified the parties to the potential ADR proceeding; (iii) identified the scope of the potential ADR proceeding and (iv) set forth the timing of the potential ADR proceeding.  The court found these terms were sufficient to constitute a binding agreement to mediate and/or arbitrate the dispute, and to the extent any other terms needed to be supplied, the parties should look to the Federal Arbitration Act.

 

Court of Chancery Critically Reviewing “Mootness” Fee Applications

In two recent decisions, the judges of Delaware’s Court of Chancery have demonstrated their intent to carefully review fee applications made by counsel for stockholder plaintiffs where the litigation has been rendered moot by actions of the company, and the litigation has been dismissed.

In In re Xoom Corp. Stockholder Litigation, C.A. No. 11263-VCG (Aug. 4, 2016), Vice Chancellor Glasscock awarded plaintiff’s counsel fees of $50,000 (of a requested $275,000) after the company rendered the litigation moot by making supplemental disclosures in advance of a transaction, and which were only marginally beneficial to the stockholders.   A few weeks earlier, in In re Keurig Green Mountain, Inc. Stockholders Litigation, C.A. No. 11815-CB (July 22,2016)(trans. ruling), Chancellor Bouchard refused to award any fees to plaintiff’s counsel (of a requested $300,000) where he found the additional disclosures by the company in advance of the transaction were of no additional value to the company’s stockholders.

A “mootness” fee application is typically filed by counsel for class or derivative plaintiffs where their litigation has arguably caused the company to take action that renders the pending litigation moot.  In the two cases discussed here, that action took the form of supplemental disclosures in advance of a stockholder vote to approve a transaction.  Once it has been determined (or conceded) that the actions of the stockholder plaintiff caused the company to take the mooting action, the court will apply “a subspecies of the common-benefit doctrine, which recognizes that, where a litigation provides a benefit to a class or group, costs necessary to the generation of that benefit should also be shared by the group or its successor.”  See In re Xoom, at p. 8.

In the Xoom matter, Vice Chancellor Glasscock declined to apply the “plainly material” standard for reviewing the value of disclosures to stockholders in advance of a stockholder vote that was announced in the Court’s earlier decision in In re Trulia, Inc. Stockholder Litigation, 129 A.3d 884 (Del. Ch. 2016).  He held that where the court is reviewing a proposed settlement that includes a broad release of claims by the stockholders, the “plainly material” standard would be appropriate.  Where, however, no such release is being sought (as in Xoom, where the litigation had been dismissed, with prejudice, as to the named plaintiff only), the Vice Chancellor found that a fee could be awarded where the disclosures have provided “some benefit to stockholders.”  To determine the fee that might be appropriate in the circumstances, the court will look to the five factors announced in Sugarland Indus., Inc. v. Thomas: (1) the benefit achieved; (2) the contingent nature of the undertaking; (3) the difficulty of the litigation and the efforts of counsel; (4) the quality of the work performed; and (5) the standing and ability of counsel.

Looking primarily at the benefit achieved, in Xoom the court found that the requested fee of $275, 000 was not warranted where the benefit achieved was marginal and where the effort expended by counsel (63 hours) on the matter would result in an implied hourly rate of $4,000/hr.  Instead, he awarded counsel for the plaintiff a fee of $50,000, which reflects an implied hourly rate of $794.00/hr.

In the Keurig matter, Chancellor Bouchard also looked primarily at the benefit achieved by the litigation efforts of the stockholder plaintiff and found that the supplemental disclosures made by the company to moot the litigation did not “confer any benefit on the corporation because they did not correct a materially misleading disclosure” in the original proxy materials.  Because he found no benefit at all had been achieved, the Chancellor rejected, in whole, the request by plaintiff’s counsel for a fee of $300,000.

Richard L. Renck
Richard L. Renck

Citing “Issue Preclusion,” the Delaware Court of Chancery Denies Advancement to a Company’s Vice President

The Delaware Court of Chancery typically holds that a corporation must advance the fees and expenses of an executive or officer-level employee who is required to defend a civil, criminal, administrative or investigative action by virtue of his or her employment with the company. Recently, however, Vice Chancellor J. Travis Laster held that a plaintiff was not entitled to advancement because he did not prove that someone with the bare title of “Vice President,” without any managerial or supervisory responsibilities, fit within the definition of “officer” found in the relevant bylaws.

The Court of Chancery’s holding in Aleynikov v. The Goldman Sachs Group, Inc., C.A. No. 10636-VCL (Del. Ch., July 13, 2016) was based, in large part, on its conclusion that it was bound by an incorrect finding by the Third Circuit in a related action because the doctrine of “issue preclusion prevent[ed] relitigation of wrong decisions just as much as right ones.”

To read the full text of the Alert, please visit www.duanemorris.com.

Update on Fee Shifting or Forum Selection Bylaws

On June 24, 2015, the Governor of Delaware signed Senate Bill No. 75, which amends the DGCL and (1) prohibits charter or bylaw provisions that would shift the company’s fees and costs of  an unsuccessful “internal corporate claim” to the stockholder prosecuting that claim, but (2) allows the certificate of incorporation or bylaws to specify that internal corporate claims be brought only in the courts of Delaware.  The text of the amendments may be accessed here.

The prohibition on fee shifting provisions was accomplished via amendments to Sections 102(f) and 109(b) of the DGCL, which provide that the certificate of incorporation or the bylaws “may not contain any provision that would impose liability on a stockholder for the attorneys’ fees or expenses of the corporation or any other party in connection with an internal corporate claim, as defined in Sec. 115 of this title.”

The Bill also created a new Section 115 of the DGCL, which addresses forum selection provisions in a company’s governance documents.  That new section provides in its entirety:

The certificate of incorporation or the bylaws may require, consistent with applicable jurisdictional requirements, that any or all internal corporate claims shall be brought solely and exclusively in any or all courts in this State, and no provision of the certificate of incorporation or the bylaws may prohibit bringing such claims in the courts of this State.  “Internal corporate claims” means claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery.

The Bill also contains fairly significant revisions to Section 204, which allows for the ratification of defective corporate acts and stock, and which we will highlight in an upcoming post.

Corporate Governance In Chapter 11 – Business As Usual, With Possible Exceptions

Under the Bankruptcy Code, a debtor in possession operates its business “as usual” during the pendency of a case. Likewise, in most cases, prepetition corporate governance practices and procedures should continue post-petition. In fact, as Judge Sontchi recently held in In re SS Body Armor I, Inc., Case No. 10-1125(CSS) (Bankr. D. Del. April 1, 2015), the right of a shareholder to compel a shareholders’ meeting for the purpose of electing a new board of directors continues during bankruptcy.  Absent “clear abuse,” the automatic stay of 11 U.S.C. §  362 is inapplicable.`

Continue reading Corporate Governance In Chapter 11 – Business As Usual, With Possible Exceptions

Fee-Shifting Bylaws–Remain In A State of Flux

As we previously reported on this page, the topic of fee-shifting bylaws being adopted to shift the costs of shareholder litigation to shareholder plaintiffs and those who assist them has been the subject of activity in both Delaware’s courts and its General Assembly.  While the General Assembly is poised to take up the issue of fee-shifting bylaws in the new legislative session (the subject of an upcoming blog post), we wanted to report on the issuance of the first written decision from the Court of Chancery addressing a challenge to a fee-shifting bylaw that had been adopted by a stock corporation.

On March 16, 2015, Chancellor Bouchard issued his decision in Strougo v. Hollander, et al., C.A. No. 9770-CB (Del. Ch. March 16, 2015), in which he granted plaintiff’s motion for judgment on the pleadings, and which challenged the efficacy of a fee-shifting bylaw adopted by the board of directors of First Aviation Services, Inc.  It is important to note that the facial validity of fee-shifting bylaws was not before the court on this motion.  Rather, the plaintiff moved on a much narrower issue, that is, whether a fee-shifting bylaw adopted after he was no longer a stockholder–but before he filed litigation challenging conduct that occurred while a stockholder–was valid for that litigation.

The board of directors of First Aviation, at the behest of its controlling stockholder, adopted a reverse stock split that had the purpose and effect of freezing out the minority shareholders and taking the company private.  Plaintiff Strougo’s interest in First Aviation was eliminated via the transaction.  Shortly after the reverse stock split, First Aviation adopted the following bylaw:

Section VII.8.  Expenses for Certain Actions.  In the event that (i) any current or prior stockholder or anyone on their behalf (collectively a “Claiming Party”) initiates or asserts [any] claim or counterclaim (collectively a “Claim”), or joins, offers substantial assistance to or has a direct financial interest in any Claim against the Corporation or any director, officer, assistant officer or other employee of the Corporation, and (ii) the Claiming Party (or the third party that received substantial assistance from the Claiming Party or in whose Claim the Claiming Party has a direct financial interest) does not obtain a judgment on the merits that substantially achieves, in substance or amount, the full remedy sought, then each Claiming Party shall be obligated jointly and severally to reimburse the Corporation and any such director, officer, assistant officer or employee for all fees, costs and expenses of every kind and description (including, but not limited to, all reasonable attorneys’ fees and other litigation expenses) that the parties may incur in connection with such Claim.

First Aviation did not disclose to its former stockholders that it had adopted this new bylaw provision.  After the adoption of the bylaw, and unaware of its existence, former-stockholder Strougo filed suit in the Court of Chancery alleging that the reverse stock spit was unfair to the minority stockholders.  When the company informed Mr. Strougo and his counsel of the bylaw, plaintiff amended his pleading to also challenge the fee-shifting bylaw.

Chancellor Bouchard rejected the application of the fee-shifting bylaw to Mr. Strougo and this litigation.  Because the courts of Delaware have consistently construed bylaws as a contract between the company and its stockholders, he held the new bylaw could not apply to Mr. Strougo and his suit because it was adopted after he was no longer a stockholder, and thus, not a party to that “contract.”  Moreover, the litigation challenged conduct that occurred prior to the adoption of the fee-shifting bylaw.

While acknowledging the “serious policy questions implicated by fee-shifting bylaws in general” and the fact that the total value of the reverse stock split was less than $100,000, the Chancellor noted the reality that “applying the bylaw in this case would have the effect of immunizing the Reverse Stock Split from judicial review because, in [his] view, no rational stockholder–and no rational plaintiff’s lawyer–would risk having to pay the Defendants’ uncapped attorneys’ fees to vindicate the rights of the Company’s minority stockholders, even though the Reverse Stock Split appears to be precisely the type of transaction that should be subject to Delaware’s most exacting standard of review to protect against fiduciary misconduct.”

With this decision–and pending legislation on this front–the topic of how Delaware corporate entities might use bylaw provisions to control shareholder litigation continues to be a hot topic in Delaware corporate law.

 

Representative Litigation: “Mootness” Fee Awards

It is a nearly universal truth that counsel representing stockholder-plaintiffs in class or derivative litigation against (or on behalf of) Delaware entities will seek an award of fees and costs where their efforts have produced a benefit on behalf of the company or the class they represent.  This might occur via settlement or upon a successful conclusion of the litigation.  In most instances where a benefit is achieved, that benefit takes the form of a “common fund” (where there has been a payment of money) or some type of “therapeutic benefit” (for instance, amended disclosures or revised governance procedures).  Counsel for stockholder-plaintiffs also have the ability to seek an award of fees and costs where the claims asserted in representative litigation are effectively mooted by the entity taking action in response to the claims.

In recent months, the Court of Chancery has issued two letter decisions in which it refused to enter stipulations by the plaintiffs and the companies to dismiss the purportedly mooted litigation or to award a negotiated fee award to plaintiffs’ counsel unless and until the parties provided notice to the class of the dismissal and proposed fee award.   See In re Zalicus, Inc. Stockholders Litig., Consol. C.A. # 9602-CB (Del. Ch. Jan. 16, 2015)(Chancellor Bouchard); and In re Astex Pharm., Inc. Stockholders Litig., Consol. C.A. # 8197-VCL (Del. Ch. Aug. 25, 2014)(Vice-Chancellor Laster).  In both of these letter decisions, the court noted the benefit to the class of stockholders–on whose behalf the litigation was being prosecuted–of having these types of mootness dismissals (with a fee award) exposed to the watchful eyes of the purported beneficiaries so that they may police any chance of an improper “buy-off” of plaintiffs’ counsel or to “object to the use of corporate funds” by “challeng[ing] the fee payment as waste in a separate litigation.”

These two letter decisions can be read as evidence of the Court of Chancery’s re-affirmation of its role in scrutinizing the interactions of fiduciaries who purport to act on behalf of a class of stockholders or the company on one hand and the officers and directors of the company on the other.  Whether these decisions also signal an intent by the court to more carefully circumscribe fee awards for mooted claims (which have not infrequently been in the neighborhood of $250,000-$500,000) remains to be seen.

 

Why You Didn’t Fly an X-Wing Fighter to Work This Morning

Every so often, the normally staid chancellors of Delaware’s Court of Chancery are faced with circumstances allowing them more creativity in the exercise of their judicial duties than is normally required for issuing important pronouncements on issues of Delaware corporate law.  Recently, Vice Chancellor Glasscock was faced with that circumstance in Alfred v. Walt Disney, Co., et al., C.A. No. 10211-VCG (Jan. 14, 2015).  In the letter decision, the Vice Chancellor dismisses Mr. Alfred’s claims that Walt Disney Co.–as the plaintiff described it– was “stalling the next evolution of human transportation on this planet” by refusing to license the X-wing name and appearance from its Star Wars franchise for his proposed flying cars.

I simply cannot improve on the Vice Chancellor’s 15-page decision, so I commend it to you for a moment of levity.  On Monday morning as you climb into your Ford, Chevy, Toyota, or Jeep (with its tires firmly on terra firma) for your morning commute, know that Walt Disney Co. has been absolved of responsibility for that reality.

Conditions on Statutory Inspections of Corporate Books and Records

In United Technologies Corp. v. Treppel, No. 127, 2014 (Del. Dec. 23, 2014), the Supreme Court of Delaware reiterated the Court of Chancery’s wide discretion in placing reasonable conditions on a shareholder’s right to inspect corporate books and records pursuant to Section 220(c) of the DGCL.  In this opinion, the Supreme Court highlights the statutory grant of discretion to the Court of Chancery to impose reasonable conditions on the inspection of corporate books and records, and discusses the body of precedent that applies that discretion.

A common condition to the exercise of the statutory inspection right is the entry into a reasonable protective order designed to protect the confidentiality of the Corporation’s information.  Here, the company sought to add a provision to the protective order that would limit the stockholder’s ability to use the results of the inspection by requiring that “any claim, dispute, controversy or causes of action . . . arising out of, relating to, involving, or in connection with” be brought in a court in Delaware.  Treppel refused to consent to such a provision and filed a Section 220 suit in the Court of Chancery.  In a bench decision in January 2014, the Court of Chancery rejected the proposed condition and held that such a limitation “is not the type of restriction that 220(c) seeks to impose.”  United Technologies appealed.

The Supreme Court reversed and remanded based upon its holding that because “the plain text of Sec. 220(c) provides broad power to the Court of Chancery to condition a books and records inspection, the court erred in determining that it lacked authority under the statute to impose the requested restriction.”  The Supreme Court, however, declined the invitation to pass judgment on the particular clause at issue and remanded for the Court of Chancery to exercise its own discretion–in the first instance–in determining whether under the facts of this particular dispute such a condition might be warranted.  The Supreme Court highlighted the following facts as being relevant to that determination: (1) the potential claims Treppel might file arise out of conduct that has already been challenged in a derivative suit in the Court of Chancery; (2) the company’s interest in having consistent rulings on related issues of Delaware law; (3) the fact that the company had–during the course of the litigation–adopted a forum selection bylaw specifying Delaware as the forum for any litigation related to the company’s internal affairs; and (4) the investment the company had already made in Delaware in addressing not only this matter, but also a previous derivative suit challenging related conduct.

Advisors of Delaware corporations should keep an eye on the remanded proceedings in the Court of Chancery, as this may become yet another tool in the corporate tool kit to combat multi-jurisdictional litigation and drive all litigation involving the internal affairs of a Delaware corporation to one specific jurisdiction.