A Stockholder Plaintiff is Not Entitled to Fees for Pursuing Personal Interests that Happen to Provide Some Corporate Benefit

On February 5, 2020, the Court of Chancery, in Martin v. Harbor Diversified, Inc., 2020 WL 568971 (Del. Ch. Feb. 5, 2020), rejected a plaintiff’s petition for attorneys’ fees because the related lawsuit was motivated by the plaintiff’s interest in a buyout of his shares and the corporate benefit produced was “a mere externality.”  Following the plaintiff’s appeal, the Delaware Supreme Court affirmed the Court of Chancery’s holding.  See Martin v. Harbor Diversified, Inc., 2020 WL 7640719 (Del. Dec. 22, 2020).

In Martin, the plaintiff, a stockholder of defendant Harbor Diversified, Inc. (“Harbor”), initiated an action under Section 220 of the General Corporation Law (the “DGCL”) to inspect Harbor’s books and records, and under Section 211 of the DGCL to compel an annual stockholder meeting.  After a trial on a paper record, the Court of Chancery ordered Harbor to hold an annual meeting and to produce certain of the corporate records sought.  The plaintiff then petitioned the Court to have $673,691 in attorneys’ fees paid by Harbor because the plaintiff’s lawsuit purportedly conferred corporate benefit and the defendant acted in bad faith.

The Court explained that under the corporate benefit doctrine, a plaintiff is entitled to have its attorneys’ fees and expenses paid by the company where the lawsuit conferred a non-monetary valuable benefit upon the corporation or its stockholders.  But, neither a company nor its stockholders shall be compelled to share in the costs of a litigation pursued primarily in the best interest of a plaintiff-stockholder.  The plaintiff, in this case, asserted that his lawsuit conferred a corporate benefit on Harbor by (i) compelling an annual stockholder meeting and facilitating director elections, and (ii) forcing Harbor to disclose its ownership structure, the identities of its management and directors, its ownership interests in certain entities, and related-party dealings.

While the plaintiff was right that his lawsuit provided some benefit to Harbor and its stockholders, the Court of Chancery declined to award fees and expenses to the plaintiff because he pursued his lawsuit against Harbor mostly for his personal benefit, seeking to be bought out by Harbor.  That conclusion was driven, at least in part, by the plaintiff’s books and records demand letter, which stated a purpose of obtaining information regarding the value of the plaintiff’s stock and the value of Harbor’s assets. “While the demand letter makes reference to the fact that Harbor had not had a stockholder meeting since October 25, 2011, there is no demand to hold a meeting.”  In fact, the plaintiff did not request an annual meeting until he filed his initial complaint.  The plaintiff’s counsel also sent several letters to Harbor, seeking financial information “related primarily to the Plaintiff’s interest in selling his shares.”

Moreover, the bulk of the effort expended in the litigation was not to achieve the stockholder meeting since Harbor’s answer to the complaint conceded that Harbor had not held a meeting from 2012 through 2018.  And, on the first page of Harbor’s pre-trial brief, the company recognized its obligation to hold an annual meeting and committed to do so.  Thus, “[a]ny effort required to achieve a meeting, in other words, was de minimis.”  In light of these circumstances, the Court determined that the corporate benefits produced by the plaintiff’s claims were “a mere externality to the Plaintiff’s ultimate goal of achieving a buyout of his interest.”

The Court of Chancery further found that none of Harbor’s conduct constituted bad faith and, as a result, denied the plaintiff’s request for fees and expenses on that basis.

Takeaway

It is not abnormal for a stockholder client to inquire whether filing a summary proceeding of some sort might inconvenience a corporation and its management enough to shake loose a buyout or some other favorable resolution.  But, as Martin v. Harbor Diversified, Inc. teaches, if the stockholder’s primary purpose is personal gain, the Court of Chancery is unlikely to award attorneys’ fees to the plaintiff.  While this decision has no bearing on the Court’s evaluation of the merits of a stockholder’s self-interested claim, the likelihood that the Court will deny a petition for fees requires a stockholder-plaintiff to consider whether the benefits it may derive from such a litigation are worth the related fees.

Zooming off to Trial: Tips & Thoughts for an Effective Virtual Trial

For the last ten years, I have had the pleasure of litigating before state and federal courts in Delaware (among other jurisdictions).  The judges in Delaware are as advertised: whip smart, extremely hardworking, knowledgeable about the issues before them, and voracious readers of each submission to their court.  The consistent excellence of Delaware judges creates an expectation that lawyers appearing before Delaware courts be equally prepared, focused on issues helpful to the trier of fact, and skillful with their arguments.  Even for experienced Delaware lawyers, demonstrating the proficiency expected by Delaware courts at in-person trials and hearings already was difficult.  That challenge has become even greater now that the COVID-19 pandemic has relegated litigants to the virtual realm — a reality that might outlive the health crisis.  Reflecting upon a recent trial before the Court of Chancery, I concluded that virtual proceedings, while possible from the comfort of your home, are worthy of at least as much planning and intentionality as a live appearance.  Below are some of my thoughts on the subject.

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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.

Yet Another Minute About Minutes

Photo by @spokane1997

The minutes of corporate board meetings are, candidly, too often treated as an afterthought.  This can lead to the official records being deemed not much of a record at all when later reviewed.  Indeed, a reviewing court might even draw certain inferences based on what it finds, or does not find, in the minutes.  I have discussed in this blog several times (here and here) certain nuances that go into the craft that is drafting a set of board minutes that properly memorialize the directors’ fealty to their roles as fiduciaries.

A recent opinion from the Court of Chancery demonstrates why, even at the time of setting the agenda for a board meeting, the corporate secretary should be cognizant of how that meeting will be memorialized in the corporate books and records.  In an April 27, 2020, Memorandum Opinion in Hughes v. Hu, et al., C.A. No. 2019-0112-JTL, the Vice Chancellor drew certain plaintiff-friendly, pleadings-stage inferences in ruling on a motion to dismiss based on what was–and more importantly, what was not–included in the corporate board minutes regarding the topics in dispute (this Blog addressed the substantive matters in dispute here).

Critical to the court’s analysis was that prior to filing his complaint, the stockholder plaintiff had exercised his rights under Section 220 of the Delaware General Corporation Law to examine the books and records of the company.  While the company had produced for inspection some books and records, the company stipulated that “any remaining materials requested by Plaintiff either do not exist or had been withheld on privilege grounds.”  Thus, the court held that “if the Company failed to produce a document that it would reasonably be expected to possess if a particular event had occurred, then the plaintiff is entitled to a reasonable inference that the event did not occur.”

The court used that holding as the basis for drawing a number of inferences in the plaintiff’s favor based on what was not included in or with the corporate minutes.  For instance, in multiple instances where the corporate minutes referred to a document or presentation that the directors purportedly reviewed, but where no copy of such document was produced for inspection with the minutes in the Section 220 proceedings, the court inferred that such materials did not exist, and therefore were not reviewed by the directors in carrying out their duties.

Moreover, the court also drew substantive inferences in plaintiff’s favor of the anticipated contents of documents referenced in the minutes but not appended to or presented with the such minutes.  For instance, a set of minutes stated that the Audit Committee approved a “Policy of Related-Party Transactions Relating to JV Shareholder,” but no such policy had been presented with the corporate books and records for inspection by the stockholder.  Thus, the court held: “It is reasonable to infer at the pleading stage that the policy did not place meaningful restrictions on management.”

Finally, it is worth noting that  the court also highlighted in multiple places throughout the opinion the overall landscape presented by the corporate books and records.  Specifically, the court noted relatively long gaps between meetings of the audit committee, the types of tasks the directors were purportedly undertaking at such meetings, and the actual length of the meetings themselves.  For example, the court held it was “reasonable to infer that with the Audit Committee having not met for almost a year, there was no possible way that the Audit Committee could have fulfilled all of the responsibilities it was given under the Audit Committee Charter during a fifty-minute meeting.”

This opinion sheds light on the potential issues that might arise where corporate secretaries (or their counsel) have allowed the task of recording minutes of board meetings to become a mere footnote in the process of keeping accurate and meaningful corporate books and records.  Based on this opinion, corporate record-keepers might:

  • In setting the agenda, give thought to how the meeting is going to flow with an eye to what the written minutes will ultimately record for history.  That is, consider the order in which topics are discussed, the relative nature and materiality of each discussion topic, and the time reasonably necessary for the directors to effectively educate themselves about that matter, discuss it, and take action.  The minutes should then reflect and record this flow of information, debate, consideration, and action by the directors.
  • Consider what documents or presentations will be provided to the directors for review and discussion and whether such materials should be provided to the directors in advance of the meeting.
  • Give thought to what materials–if any–will be appended to minutes in the official books and records of the company.

Drafting minutes that properly record the material events in the life of a board of directors is an art more than a science, but like the classical orders of ancient art and architecture, the gloss from judicial decisions of the courts can define characteristics of minutes that bring that art to life in ways that unmistakably portrays director behavior fully complying with fiduciary norms.

A STOCKHOLDER OWES NO FIDUCIARY DUTIES WHEN IT IS NOT IN CONTROL [GROUP]

by Oderah C. Nwaeze

The Court of Chancery’s April 29, 2020 decision in Gilbert v. Perlman et al. supports the conclusion that a company’s minority stockholder cannot be considered part of a “control group” (and therefore will not owe fiduciary duties to the company and other minority stockholder) unless the controlling stockholder cedes some material aspect of its control to the minority stockholder as part of an agreement to act in concert to achieve a corporate action.

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BETTER OVERSIGHT THAN HINDSIGHT: Hughes v. Xiaming Hu demonstrates that directors and officers who fail to adequately oversee their company’s management expose themselves to personal liability

By Oderah C. Nwaeze

Across the United States, the Coronavirus has caused widespread devastation, marking its arrival with debilitating symptoms and tens of thousands of deaths.  The virus also is responsible for significant economic destruction, rendering 30 million Americans jobless requiring $660 billion in payroll loans, and necessitating a $2.2 trillion in stimulus package.  History likely will reveal that poorly run companies are repeat victims of the financial hardships precipitated by COVID-19.  Even without a pandemic, a company likely will fail (or suffer significant harm) if its directors and officers do not adequately oversee the company’s management.  But, there is another reason to avoid oversight failures.  As the Delaware Court of Chancery’s April 27, 2020 decision in Hughes v. Xiaming Hu et al. reinforces, directors and officers who neglect their oversight responsibilities may be personally liable for resulting harm to the company and its stockholders.

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Delaware Supreme Court Permits Delaware Corporations to Include Federal Forum Provisions in Their Charters & Bylaws

By: Oderah C. Nwaeze and James J. Regan

On March 18, 2020, the Delaware Supreme Court reversed the Delaware Court of Chancery’s decision in Sciabacucchi v. Salzberg, 2018 WL 6719718 (Del. Ch. Dec. 19, 2018), which had held that federal forum provisions (FFPs) for claims under the Securities Act of 1933 (’33 Act) are facially invalid and therefore cannot be included in a Delaware company’s charter or bylaws.

The Delaware Supreme Court’s holding that Delaware corporations may add FFPs to their charter and bylaws is a positive development for companies that wish to trade the uncertainty and expense of defending multiple lawsuits in various state and federal court jurisdictions for the steady guidance of a venue with the background and experience necessary to resolve disputes under the ’33 Act.

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Delaware Governor Issues Emergency Order Regarding Corporate Annual Meetings

I recently discussed on this page how the 2020 corporate annual meeting season was facing its own challenges in the midst of the global pandemic and worldwide orders against the congregation of persons, and discussed the potential use of virtual annual meetings being conducted remotely by electronic communications as a means to overcome such challenges.  On the evening of April 6, 2020, the Governor of the State of Delaware issued his Tenth Modification to the Covid-19 State of Emergency, which contained provisions fostering a Delaware corporation’s ability to react where it had already called and noticed an annual meeting of stockholders to be held in-person.

The Tenth Modification of the Covid-19 State of Emergency permits Delaware corporations subject to the  reporting requirements of Section 13(a) and 15(d) of the Securities Exchange Act of 1934, and who have already given notice of an in-person annual meeting of stockholders, to either (a) convene the meeting as scheduled but via electronic “virtual” means or (b) adjourn the meeting to another date to be held remotely via electronic means by both (i) making a public filing with the SEC giving notice of such changes to the convening of the meeting, and (ii) publishing the notice on the company’s website.

A PLAINTIFF CANNOT SATISFY THE FIRST PRONG OF ARONSON BY ALLEGING THAT THE BOARD’S “INTEREST” IN THE SETTLEMENT AT ISSUE WAS TO AVOID A CLAIM SO WEAK THAT PLAINTIFF DECLINED TO BRING IT

On April 2, 2020, Vice Chancellor Slights dismissed a derivative lawsuit that alleged that a Company’s Board breached its fiduciary duties by rushing to pay an “excessive” severance fee in order to facilitate the CEO’s separation from the Company, and as a means to cover up the Board’s slow and inadequate response to the CEO’s pattern of wrongful conduct.  According to the Court of Chancery, Plaintiff’s claims were betrayed by the Complaint’s failure to demonstrate demand futility under either prong of the standard described in Aronson v. Lewis, 473 A.2d 805 (Del. 1984).

Of note in this decision is that the Court of Chancery affirms the principle that, under typical circumstances, a general release provision in a settlement agreement (including the release of claims against directors) cannot form the basis of allegations that a board engaged in an “interested transaction.”  That is especially true, where, as in this case, the claim purportedly avoided is one that is so weak that the Plaintiff elected not to bring it and raised it only in an effort to identify the Board’s interest in the Separation Agreement under the first prong of Aronson.

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Annual Meetings–When Your Stockholders Cannot Actually Meet

As I write this post safely ensconced—and properly “socially-distanced”—in my home office, the annual rites of spring march on oblivious to the disruption caused by a global pandemic. The bulbs outside my window are in full-bloom, trees are budding out, and spindly-legged foals gambol about in their paddocks. Corporate annual meetings (another rite of spring), however, are not so immune. Millions of stockholders of Delaware corporations are currently under some form of “stay-at-home” restrictions, and applicable guidelines from health officials limit gatherings to no more than 5-10 people, each of which have to be at least 6 feet away from one another.  These safety protocols, while necessary, make it essentially impossible to convene annual stockholders’ meetings as has been traditional–in person.

In this time of extreme disruption, Delaware corporations may continue to carry on the critical business attended to at the annual meeting of stockholders by taking advantage of the flexibility granted by the Delaware General Corporation Law (“DGCL”) to conduct such annual meetings “virtually” via electronic means. Moreover, as described below, Delaware corporations may also be given the freedom to delay their annual meetings until the biological dangers of in-person meetings have passed.

“Virtual” Annual Meetings

Section 211 of the DGCL was amended at the turn of this century to authorize corporations to hold annual meetings of stockholders “by means of remote communication” so long as it was not prohibited by the corporation’s charter or bylaws and was approved by the board of directors. Section 211 further gives the board sole discretion to adopt guidelines and procedures that would allow stockholders (or proxy-holders) to utilize “means of remote communications” such that they may:

1) participate in the stockholders’ meeting, and;

2) be deemed present in person and vote at a meeting of stockholders, provided that:

(i) the company implements reasonable measures to verify that each person deemed present and permitted to vote at the meeting by means of remote communication is a stockholder or proxyholder,

(ii) the company implements reasonable measures to provide its stockholders and proxyholders a reasonable opportunity to participate in the meeting and to vote on matters submitted to the stockholders, including an opportunity to read or hear the proceedings of the meeting substantially concurrently with the proceedings, and

(iii) if any stockholder or proxyholder votes or takes other action at the meeting by means of remote communication, a record of such vote or other action will be maintained by the company.

Corporations considering utilizing the freedom offered by Section 211 to conduct their annual meetings virtually should consult their governing documents to determine whether such meetings would be prohibited, and if not prohibited, the board of directors should establish proper procedures to ensure compliance with Section 211. If a virtual meeting is, however prohibited by the governing documents, and that prohibition is contained in the company’s bylaws, then the board of directors may have the power to amend the bylaws to allow annual meetings to be conducted by remote means.

Delayed Annual Meetings

To the extent a Delaware corporation has already given notice of an “in-person” annual meeting, another option may be to delay the convening of such a gathering until it is both safe and permitted by local orders. To the extent a company decides to delay its annual meeting, among the issues that might need to be addressed are: (a) federal securities laws and regulations related to notices and solicitations of proxies (recent SEC guidance on this front is addressed here), and (b) Delaware state-law matters related to the timing of annual meetings. For instance, DGCL Section 211 mandates that a corporation convene an annual meeting no later than 13 months since the last annual meeting or the last time directors were elected by written consent. Thus, a delayed annual meeting could run afoul of this timing constraint.

As of this morning, however, it appears that the Delaware State Bar Association (“DSBA”) is working on emergency proposals for the Governor and the General Assembly that would, if presented and adopted, (a) make clear in DGCL Section 110(a) that a pandemic or epidemic is a type of emergency that could trigger a board’s ability to adopt emergency bylaws, and (b) give the board of directors broad powers regarding the timing of and method of convening an annual meeting of stockholders beyond those discussed above. These proposed measures are currently making their way through the DSBA committee process.

These are rapidly-evolving times, so stay tuned for future developments on this front.