Chancery Finds Stockholders’ Covenant Not to Sue for Breach of Fiduciary Duty of Loyalty Partially Enforceable

The Court of Chancery on Tuesday held that stockholders’ covenants not to sue for breach of fiduciary duty are enforceable subject to public policy limitations in New Enterprise Associates 14, L.P. v. Rich, C.A. 2022-0406-JTL.  Conducting a deep-dive into the history and philosophical underpinnings of fiduciary law, the Court reasoned that specific, limited, and reasonable covenants not to sue are valid, but that Delaware abhors pre-dispute waivers of suit for intentional harms.  The Court laid out a two-part test, sure to join the corporate practitioner’s lexicon of eponymous capital-t Tests swiftly:

First, the provision must be narrowly tailored to address a specific transaction that otherwise would constitute a breach of fiduciary duty.  The level of specificity must compare favorably with what would pass muster for advance authorization in a trust or agency agreement, advance renunciation of a corporate opportunity under Section 122(17), or advance ratification of an interested transaction like self-interested director compensation.  If the provision is not sufficiently specific, then it is facially invalid.

. . .

Next, the provision must survive close scrutiny for reasonableness. In this case, many of the non-exclusive factors suggested in Manti point to the provision being reasonable. Those factors include (i) a written contract formed through actual consent, (ii) a clear provision, (iii) knowledgeable stockholders who understood the provision’s implications, (iv) the Funds’ ability to reject the provision, and (v) the presence of bargained-for consideration.

Finding the covenant at issue passed the test, the Court held the covenant enforceable subject to Delaware’s policy against exculpating intentional harms.  To invoke that policy, and thereby avoid the covenant and obtain damages, a plaintiff must plead and prove that the fiduciaries acted in a manner contrary to the company’s best interest in “bad faith,” a more stringent standard than even recklessness.

Critical to the Court’s analysis was the anti-suit covenant’s placement in a stockholder-level agreement.  As the Court explained in an over-1200-word footnote discussing different conceptions of the fundamental nature of the corporate form, the covenant’s contractual placement means it merely “addresses a stockholder right appurtenant to the shares that the Funds owned as their private property” without raising the logical, practical, and normative difficulties arising from placement in the corporation’s constitutive documents, i.e. the bylaws or charter.   

Do New Delaware General Corporation Law Exculpation Amendments Trigger a Mandatory Class Vote for Changes to Charters?

In August 2022, a number of amendments to the provisions of the Delaware General Corporation Law (DGCL) went into effect. One amendment of note is the extension of Section 102(b)(7)’s exculpation provisions, which now permit corporations to eliminate or limit the personal liability of specified officers for direct claims of breach of the fiduciary duty of care. As a result, several Delaware corporations have amended their charters to extend the Section 102(b)(7) clauses to those senior corporate officers specified under the newly amended statute. Naturally, these actions bring a new issue for the courts to determine: What is the requisite stockholder approval to implement these charter amendments?


To read the full Alertvisit the firm website

Court of Chancery Refuses to Blue Pencil “Facially Unenforceable” Non-Compete Agreement

A few weeks ago, we wrote about a decision where the Court of Chancery denied injunctive enforcement to a non-compete agreement because the agreement was likely void under Alabama law, and Alabama’s much closer relationship to the labor market at issue overcame an otherwise-valid choice-of-law clause pointing to Delaware.  This week, the Court of Chancery has once again found a non-compete agreement unenforceable in Intertek Testing Services NA, Inc. v. Jeff Eastman, 2022-0853-LWW (March 16, 2023), this time ruling that it was overly broad and ineligible for judicial narrowing under Delaware law.

New York-based Intertek purchased Alchemy Investment Holdings, Inc., a Texas-based workforce management services business of which Eastman was a stockholder-CEO in 2018.  The acquisition agreement included a clause restricting a group of people, including Eastman, from competing with Alchemy “anywhere in the world” for five years from the date of transaction.  More than two years later, Eastman’s son formed a company which provides services to clients in the cannabis industry analogous to Alchemy’s offerings.  Eastman is a director and investor in his son’s company.  Intertek filed suit, and Eastman moved to dismiss.

Vice Chancellor Will reasoned that while Delaware will enforce broad restrictive covenants accompanying the sale of a business, even including international restrictions, the covenants must still be “tailored to the competitive space reached by the seller and serve the buyer’s legitimate economic interests.”  Because the global scope exceeded Alchemy’s at-most-nationwide market, the clause at issue was overbroad and thus “facially unenforceable.”  The Court further refused on equitable grounds to “blue pencil” a more reasonable alternative geographic scope, citing prior Delaware cases which discussed the troubling incentivization to overreach that the Court creates when it permits a sophisticated employer/buyer to narrow an otherwise-overbroad clause post hoc.

Because the Vice Chancellor also found no well-pleaded allegations that Eastman breached the non-solicitation or confidentiality provisions of the agreement, she granted Eastman’s motion and dismissed the action.

Demand Futility Saves McDonald’s Former Executive from Potential Caremark Liability

We discussed in a prior Alert Vice Chancellor J. Travis Laster’s extension of oversight duties and liability therefrom upon corporate officers. While this decision provided answers to long-standing questions relating to the extension of oversight duties, it also brought about concerns regarding the potential increase of exposure to liability. Luckily for those who shared in this concern, Vice Chancellor Laster reminded us all that the requirement to plead demand futility under Court of Chancery Rule 23.1 will continue to serve as an important hurdle to a plaintiff’s success in the courtroom. In a short order released this month, Vice Chancellor Laster dismissed the same breach of oversight claims that previously withstood Court of Chancery Rule 12(b)(6) muster.

To read the full Alertvisit the firm website.

Consent to Jurisdiction Clauses–The Sequel

We recently wrote a post on this page discussing a new decision of the Court of Chancery holding that a consent to jurisdiction clause in a corporate acquisition agreement was not drafted such that its scope covered claims for breach of fiduciary duty–the lesson for drafters of agreements being to carefully consider how the provision being drafted actually covers the intended scope and types of claims.

In a decision issued on February 28, 2023, the Court of Chancery issued its decision in Golden v. Shootproof Holdings, LP, et al., C.A. No. 2022-0434-MTZ, in which the court considered whether the consent to jurisdiction clause in a merger agreement covered individuals (officers of the buying entities) who were not signatories to, or parties to, the merger agreement at issue.  The court found that it did not have personal jurisdiction over the two individual defendants, both residents of Georgia, because it found–as non-parties to the merger agreement–they had not consented to jurisdiction in Delaware.  The court, therefore, granted the individual defendants’ motion to dismiss.

In arriving at this result, the court noted that it may enforce a forum selection clause against those “who are not otherwise individually bound by the agreement” where it finds all three of the following present: “(i) the agreement contains a valid forum selection provision; (ii) the non-signatory has a sufficiently close relationship to the agreement  . . .; and (iii) the claim potentially subject to the forum selection provision arises from the non-signatory’s standing related to the agreement.”  In the litigation, only factor (ii) was contested.

The court ultimately found that the individual defendants were not intended third-party beneficiaries of the merger agreement and would not be bound by the principles of estoppel, and thus, they had not consented to the jurisdiction of Delaware’s courts.

As with last week’s post, this new decision highlights how the Delaware courts are content to apply consent to jurisdiction clauses–but will only do so where the clause clearly articulates that it covers both the intended parties and the intended conduct.

Delaware Choice of Law Clauses for Restrictive Covenants in Agreements

The Delaware Business Court Insider recently published my analysis of a decision of the Court of Chancery where the court declined to apply a Delaware choice of law provision in a dispute related to restrictive covenants where the application of Delaware law would thwart an express policy of the state (here, Alabama) with the greater interest in the dispute.  That article may be read here.

Contract Drafters: Consider the Scope of Your Consent to Jurisdiction Clauses!

A new decision from Delaware’s Court of Chancery highlights how transactional lawyers are granted wide latitude to seek, by contract, to invoke the jurisdiction of Delaware’s renowned business and commercial courts, where jurisdiction might not otherwise lie, through the use of a consent to jurisdiction clause in a contract or agreement.  But in doing so, practitioners should consider carefully how the parties will ultimately define the scope and reach of such consent.  In ActiGraph Holdings, LLC, et al. v. Cyntech, Inc. et al., C.A. No. 2021-0507-KSJM (February 14, 2023), the Chancellor found that a consent to jurisdiction clause in a purchase agreement for the sale of a business (a Florida LLC) did not subject the former CEO of the sold business to the jurisdiction of the Delaware courts for purposes of claims of breach of fiduciary duty in the management and affairs of the Florida LLC.

The pertinent language in the consent to jurisdiction clause stated: “Each party hereby irrevocably submits to the jurisdiction of the Court of Chancery of the state of Delaware or any federal court of competent jurisdiction in the state of Delaware, solely in respect of the interpretation and enforcement of the provisions of this agreement and of the documents referred to in this agreement . . . .” (emphasis added by Court)  The Court held that the the emphasized language in the consent to jurisdiction clause did not cover claims for breach of fiduciary duty, and therefore found that the Court did not have personal jurisdiction over the former CEO (a Florida resident) for such claims.

Clarity at Last? Court of Chancery Confirms Corporate Officers Owe Oversight Duties

Since Chancellor William T. Allen’s seminal ruling in In re Caremark International Inc. Derivative Litigation, the question of the duties owed by corporate officers, not directors, has remained unclear. For years, practitioners, academics and the courts have grappled with this question and others. Recently, Vice Chancellor J. Travis Laster answered some of these questions and provided long-needed clarity, holding that corporate officers “owe a fiduciary duty of oversight as to matters within their areas of responsibility.”  While this opinion provides answers to the questions many have been asking, it also raises concerns.

To read the full Alert, visit the firm website.

Seek (In Delaware), and Ye Shall Find Corporate Books and Records

The right of a stockholder of a Delaware corporation to inspect the books and records of the company is codified in Section 220 of the Delaware General Corporation Law.  In recent years, and for a number of reasons, stockholders have been exercising this inspection right in ever increasing numbers (I have four clients addressing demands to inspect books and records as I write).  A recent decision of the Court of Chancery (Juul Labs, Inc. v. Grove, C.A. No. 2020-0005-JTL) is worth highlighting–less for the substantive law related to Section 220 inspections of books and records and more its discussion of certain “gatekeeping” matters related to litigation to enforce these stockholder inspection rights.

The noteworthy holdings and outcomes in the Juul Labs decision are the following:

  • Because Juul Labs is a Delaware corporation, and a demand by a stockholder to inspect the books and records of a corporation are a matter of internal affairs for that entity, the stockholder could not use a similar California statute (even though Juul’s principal place of business is in California) as a basis upon which to demand the inspection of books and records;
  • A stockholder of a Delaware corporation must look solely to 8 Del. C. Sec. 220 for its statutory rights to inspect the books and records of a Delaware corporation in which they own shares; and
  • The court left open the question whether a stockholder of a Delaware corporation can contractually waive the statutory rights to inspection of books and records granted by Section 220.

Thus, while it is clear that Delaware corporations and their legal advisors can take greater comfort that disputes over stockholder access to corporate books and records can and will be heard in Delaware, the broader question of whether Delaware corporations can affirmatively contract with their stockholders to limit or obviate such inspection rights remains to be answered.

© 2009- Duane Morris LLP. Duane Morris is a registered service mark of Duane Morris LLP.

The opinions expressed on this blog are those of the author and are not to be construed as legal advice.

Proudly powered by WordPress