All posts by Richard L. Renck

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.

 

Delaware Supreme Court Issues Important Revlon Reminder

On December 19, 2014, the Supreme Court of Delaware issued an engaging opinion reminding readers of the historical origins of the Revlon doctrine in Delaware corporate jurisprudence and reversing the Court of Chancery’s grant of preliminary injunctive relief because it was based on an erroneous view of the doctrine’s requirements.  In C&J Energy Services, Inc., et al. v. City of Miami General Employees’ and Sanitation Employees’ Retirement Trust, No. 655/657, 2014 (December 19, 2014), the Supreme Court reversed a mandatory preliminary injunction the Court of Chancery issued requiring C&J Energy Services, Inc. (“C&J”) to “go shop” itself after finding that a failure to shop the company either before or after the transaction made it “plausible” that the court would find a violation of the Revlon doctrine.

While deal-makers will find the opinion an interesting read for the discussion of a fairly unique deal structure, important to understanding the Supreme Court’s discussion of Revlon duties are the following salient facts: (1) the board was majority independent; (2) none of the directors had any prior relationship with the deal partner;  and (3) C&J bargained hard for significant corporate governance concessions that inured to the benefit of the C&J stockholders.  The corporate governance concessions included, among other things, a commitment in the by-laws of the new entity (which would be majority owned by the transaction partner for tax and purposes of domestication in Bermuda) that in the event of a future sale of the company, all shareholders would share equally and ratably in the proceeds of any such transaction.

Given the key facts noted, the Supreme Court found that “[a]lthough the record before us reveals a board process that sometimes fell short of ideal, Revlon requires us to examine whether a board’s overall course of action was reasonable under the circumstances as a good faith attempt to secure the highest value reasonably attainable.”  The Supreme Court noted that “as the years go by, people seem to forget that Revlon was largely about a board’s resistance to a particular bidder and its subsequent attempts to prevent market forces from surfacing the highest bid.”  Given that re-focus on the historical foundation for Revlon duties, the Supreme Court recited the following regarding the proper focus of a Revlon analysis:

Not only did the Court of Chancery fail to apply the appropriate standard of review, its ruling rested on an erroneous understanding of what Revlon requires. Revlon involved a decision by a board of directors to chill the emergence of a higher offer from a bidder because the [company’s] CEO disliked the new bidder, after the target board had agreed to sell the company for cash. Revlon made clear that when a board engaged in a change of control transaction, it must not take actions inconsistent with achieving the highest immediate value reasonably attainable.

But Revlon does not require a board to set aside its own view of what is best for the corporation’s stockholders and run an auction whenever the board approves a change of control transaction. As this Court has made clear, there is not single blueprint that a board must follow to fulfill its duties, and a court applying Revlon’s enhanced scrutiny must decide whether the directors made a reasonable decision, not a perfect decision.

In a series of decisions in the wake of Revlon, Chancellor Allen correctly read its holding as permitting a board to pursue the transaction it reasonably views as the most valuable to stockholders, so long as the transaction is subject to an effective market check under the circumstances in which any bidder interested in paying more has a reasonable opportunity to do so. Such a market check does not have to involve an active solicitation, so long as interested bidders have a fair opportunity to present a higher-value alternative, and the board has the flexibility to eschew the original transaction and accept the higher-value deal. The ability of the stockholders themselves to freely accept or reject the board’s preferred course of action is also of great importance in this context. (internal quotations omitted and italics in original)

This is an important opinion given its reminder that there are many ways for a board to satisfy its Revlon duties so long as the actions taken are reasonably calculated to achieve the best value reasonably attainable for the shareholders.  The key factor, however, will be the Court’s assessment of the likelihood that superior alternative proposals–if any are available–had a fair opportunity to percolate to the top, and the board maintained the ability to present those alternatives to the shareholders.

“Per Capita” v. “Per Share” Voting in Agreements–Words Matter

In Salamone, et al. v. Gorman, No. 343, 2014 (Del. Dec. 9. 2014), the Supreme Court of Delaware writes for nearly 60 pages sorting out contradictory provisions in a voting agreement that was supposed to clearly spell out the rights of various investors and investor groups to elect directors to the board.  It did not, and the Court was forced to resolve ambiguities in the document that made it unclear whether directors were to be elected and removed on a “per share” or a “per capita” basis by different classes of investors.

The voting agreement at issue intended to set forth a scheme by which, among other things, (1) one independent director was to be designated by “the majority of holders of the Series A Preferred Stock, and (2) two directors were to be “elected by the Key Holders,” who were defined in the agreement.  The potential ambiguity in the wording of the director election provisions came to the fore when compared to the director removal clause which provided, in material part, that the removal of the two types of directors noted would only be valid where “such removal is directed or approved by the affirmative vote of the Person, or of the holders of more than fifty percent (50%) of the then outstanding Shares entitled under Section 1.2 to designate that director.”

The litigation centered upon the efforts of one of the stockholders, who controlled a majority of the voting shares, to single-handedly remove and replace the independent director and the two directors to be elected by the Key Holders based on that majority voting power.  Such power would follow from a “per share” voting scheme.  The opposing parties, however, argued that the voting agreement was designed to disaggregate voting power and to give particular investors an equal voice in selecting directors to represent their respective class of equity.  Thus, they argued that the voting agreement set forth a “per capita” scheme pursuant to which the majority shareholder had just one of several votes, and thus must convince a majority of the individual investors that either held Series A Preferred or who were Key Holders to support his nominees.

After employing a host of contractual interpretation devices, the Supreme Court ultimately found that (1) the “majority of the holders” language regarding the independent director’s election referred to a “per share” basis for election and removal, and (2) that the Key Holders elected and removed their representative directors on a “per capita” basis.  In so ruling, the Supreme Court’s decision seems to turn on two important points.  First, the Supreme Court found that the election and removal provisions should be read as setting forth the same–rather than contradictory–methods for the election and removal of directors.  Second, the Court applied the judicial presumption under Delaware law that, absent clear and convincing evidence to the contrary, the Court will not infer an intent to disenfranchise a majority stockholder by recognizing that “[a] court ought not to resolve doubts in favor of disenfranchisement.”

This facts presented in this case, and the Supreme Court’s efforts to bring order to the voting agreement’s terms, show that terms like “majority of the holders” can be ambiguous in application and that carefully considering such provisions can avoid the troubles presented in this litigation.

A Bit About Break-up Fees in M&A

In In re Comverge, Inc. Shareholders Litig., C.A. No. 7368-VCP, a decision on a motion to dismiss by Court of Chancery, Vice Chancellor Parsons provided practitioners and clients with a thorough and helpful analysis (essentially a road-map) of  how the Court of Chancery reviews challenges to third-party sale transactions, that are approved by a disinterested board, under the enhanced scrutiny of Revlon.  In addition to the primer on a Revlon analysis, the opinion is worth a read for its discussion of what the Court considers the outer bounds for break-up fees.  The Vice Chancellor allowed claims challenging the break-up fees in this transaction to go forward because, when viewed in the aggregate, they could total north of 11% of the equity value.  For purposes of this motion, the Vice Chancellor accepted the plaintiff’s argument that a convertible note held by the buyer, if converted, could add more than $3 million to the purchase price if another bidder emerged, and thus should be considered an enhancer of the termination fees.  The Vice Chancellor held he could not dismiss this claims because it is reasonably conceivable that the plaintiffs might be able to show that this decision by the board was so far out of bounds as to be only explainable as “bad faith”—and thus not exculpable under a Section 102(b)(7) exculpatory clause.

Corporations Don’t Independently Owe Fiduciary Duties to Stockholders

On August 7, 2014, Vice Chancellor Glasscock issued a letter opinion in the matter Buttonwood Tree Value Partners, L.P., et al. v. R.L. Polk & Co., Inc., et al., C.A. No. 9250-VCG that is not attention-grabbing because it wrestles with some nuanced topic du jure of Delaware corporate law, but rather because it deals nearly entirely with the rather pedestrian, but not often explicated, principal that a Delaware corporation does not independently owe its stockholders fiduciary duties. Rather, fiduciary duties are owed to the stockholders (and the company) by the directors and officers who are the actual actors on behalf of the company. Continue reading Corporations Don’t Independently Owe Fiduciary Duties to Stockholders

Fee-Shifting Corporate Bylaws–The Judicial Challenges Begin

As discussed in a previous post, the Delaware General Assembly has tabled its consideration of a bill that would ban fee-shifting bylaws for traditional corporations until the next legislative session. This legislative push followed the Delaware Supreme Court’s holding, in responding to certified questions of law, that “fee shifting provisions in a non-stock corporation’s bylaws can be valid and enforceable under Delaware law”. See ATP Tour, Inc., et al. v. Deutscher Tennis Bund (German Tennis Federation), et al., No. 534, 2013 (Del. Supr. May 8, 2014). The fee-shifting bylaws being considered are designed to shift the company’s costs (including attorneys’ fees) of successfully defending against litigation prosecuted by a company’s stockholders to the stockholder plaintiff. As one might imagine, such a scenario might be seen as a “game changer” with regard to shareholder representative litigation.

Continue reading Fee-Shifting Corporate Bylaws–The Judicial Challenges Begin

Recent Developments in Business and Commercial Courts

While once somewhat of a novelty, the creation and adoption of specialized business or commercial courts—designed to adjudicate complex business and commercial disputes in an efficient manner to meet the needs of a jurisdiction’s corporate and commercial citizens—continues to mature. Moreover, the resources available discussing these specialized courts or dockets are constantly expanding.

Continue reading Recent Developments in Business and Commercial Courts