Archive:2018

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Chancery Court Denies In Part Motion to Dismiss Breach of Contract and Breach of Fiduciary Duties Claims
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Chancery Court Finds That Interested Directors Breached Their Fiduciary Duties in Granting Themselves Stock Options But Awards Nominal Damages
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Court of Chancery Dismisses Breach of Fiduciary Duty Claim as Duplicative of Breach of Contract Claim
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CONTROLLING STOCKHOLDER CANNOT ADVANCE ITS OWN SELF-INTEREST AT EXPENSE OF MINORITY STOCKHOLDERS
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Chancery Court Denies Motion to Dismiss Brought by Defendant Tesla Motors, Inc. After Concluding that Elon Musk is a Controlling Stockholder
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Court of Chancery Holds That Plaintiff Failed to Meet Burden of Proof With Respect to Mistake-Based Reformation Claim
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CHANCERY COURT NULLIFIES DISSOLUTION OF LIMITED LIABILITY COMPANIES FOR FAILURE TO SET ASIDE A RESERVE TO SATISFY KNOWN CLAIMS
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Chancery Court Limits Access to Books and Records Based on Stockholder’s Failure to State Purpose in Section 220 Demand
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PLAINTIFFS WERE UNABLE TO ROUSE SUPPORT FOR THEIR POSITION THAT A MINORITY STOCKHOLDER WAS A CONTROLLER AND BREACHED FIDUCIARY DUTIES BECAUSE THEY DID NOT PLEAD SUFFICIENT FACTS
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Chancery Court Finds Credible Basis for Demand to Inspect Books and Records of UnitedHealth in connection with Possible Medicare Overbilling

Chancery Court Denies In Part Motion to Dismiss Breach of Contract and Breach of Fiduciary Duties Claims

By Shoshannah Katz and Priya Chadha

In Feldman v. Soon-Shiong, et al. (C.A No. 2017-0487-AGB), the Delaware Court of Chancery denied in part and granted in part a motion to dismiss claims involving, among other things, breach of contract and breach of the fiduciary duty of loyalty, following a defendant’s withdrawal of $47 million from a company bank account.

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Chancery Court Finds That Interested Directors Breached Their Fiduciary Duties in Granting Themselves Stock Options But Awards Nominal Damages

By Lisa Stark and Mark Hammes

In Ravenswood Investment Company v. Winmill & Co. (C.A. No. 3730-VCS and 7048-VCS (Del Ch. March 21, 2018)), plaintiff Ravenswood Investment Company (“Ravenswood”), a stockholder of Winmill & Co. (the “Company”), brought a derivative suit against the directors of the Company, Bassett, Thomas and Mark Winmill (“Defendants”) alleging that Defendants breached their fiduciary duties in two respects. First, they granted overly generous stock options to themselves (as Company officers). Second, they caused the Company to forgo audits of the Company’s financials and to stop disseminating information to the Company’s stockholders in retaliation for Ravenswood’s assertion of inspection rights. Following a trial, the Delaware Chancery Court entered judgment for Ravenswood as to the first theory and for Defendants as to the second. After finding that there was insufficient evidence to support cancellation, rescission, rescissory damages or some other form of damages, the Court awarded nominal damages to the Company of $1 per Defendant.

In Ravenswood, the Company provided investment management services and its shares were traded on NASDAQ until it was delisted in 2004, and then over-the-counter on the Pink Sheets. During all relevant time periods, Defendants comprised the entirety of the board of directors of the Company. They were also founders, stockholders, and officers of the Company. When the Company’s 1995 stock option plan expired in 2005, Defendants, in their capacity as directors, adopted a new performance equity plan (the “PEP”). Each Defendant, in his capacity as an officer of the Company, received options to purchase 100,000 shares of stock at $2.948 per share under the PEP. At the time, approximately 1.5 million shares were outstanding and the Company’s stock traded at $2.68 per share. The Defendants chose not to hire a compensation consultant, instead relying on their own ad-hoc analysis of comparable companies, many of which were much larger than the Company.

Approximately 18 months later, each of the Defendants exercised options to purchase 66,666 shares. Each Defendant paid $1,532.39 in cash and gave a $195,000 promissory note to the Company for the remainder of the purchase price. Following the exercise, each of the Defendants paid interest on the notes, but a little over a year later, in April 2008, in their capacity as board members, they forgave Thomas’ note entirely and forgave Mark’s note in three tranches over three years. Although Bassett’s note was not forgiven, later he became unable to pay the note when due and entered into a replacement note with a longer maturity. Years later, following his death, his estate finally paid off the note.

In addition, following the Company’s delisting, it continued to prepare audited financial statements until 2011, when, for cost reasons, the Defendants decided not to engage in further audits and ceased distributing financial information to stockholders.

Plaintiffs brought suit on a number of theories, which by the time of the trial, had been reduced to two theories for violation of the Defendants’ fiduciary duty of loyalty: first, that the stock options were improperly authorized and granted, and second, that the Defendants’ decision to cease distributing financial information was an improper decision in retaliation against Plaintiff, who had previously brought an action against Defendants.

After a two-day trial, the Court entered judgment for the Plaintiff on the first theory and for Defendants on the second. As to the first claim, the Court first held that the entire fairness standard applied to the PEP adoption and stock option grants as “[d]irectors who stand on both sides of a transaction have the burden of establishing its entire fairness.” The Court explained that entire fairness requires a showing that directors acted with utmost good faith and the most scrupulous inherent fairness of the bargain. This requires a showing of both fair dealing and fair price.

In analyzing fair dealing, the Court described the Defendants’ process as “neither well-documented nor well-substantiated” and in fact stated that “the term ‘process’ does not really fit here; the evidence reveals that there really was no process.” There were no contemporaneous records and no indication that the board sought the advice of any outside advisor or consulted any literature or other sources. Defendants’ only decision-making tool appeared to be comparing the PEP and proposed options to compensation plans of alleged peer companies, but the Court described this tool as “severely flawed” due to labelling companies as peers in a way that was “simply not credible” because nearly all of them were much larger than the Company. Thus the Court concluded that the stock option grants were not the result of fair dealing.

The Court next analyzed the fairness of the pricing of the options. The Court held that the initial price was fair, but the Company’s actions in forgiving notes resulted in a total payment for the options that was not fair. The Court explained that these decisions may have made perfect sense if this family business were really a family business where the Defendants were the only stakeholders, but in a public company setting these decisions resulted in an unfair price and thus a breach of the Defendants’ fiduciary duties.

The Court denied the Plaintiff’s second theory, explaining that Delaware law presumes that the directors of a Delaware corporation make business decisions on an informed basis and in the honest belief that their decision is in the corporation’s best interests. To overcome that presumption, plaintiffs must show that directors “appeared on both sides of the transaction or derived a personal benefit from a transaction in the sense of self-dealing.” The Court held that since Plaintiff had presented no evidence that the Directors ceased distributing financial information due to an improper motive rather than their claimed rationale of lowering costs and reducing the risk of disclosure-related litigation, Defendants were entitled to the protection of the business judgment rule and did not breach their fiduciary duty with respect to the second theory.

Finally, the Court discussed potential remedies. Plaintiff sough compensatory damages, but the Court held that it failed to present any evidence upon which the Court could award compensatory damages to the Company. Plaintiff also sought cancellation of the shares or rescission, but the Court explained that cancellation and rescission would not be appropriate without returning the parties to the status quo ante, which would require returning to Defendants what money they had paid for the shares. Since the Company lacked the funds to do so, these remedies were not appropriate. Finally, the Court held that Plaintiff had also failed to present evidence on which the Court could award rescissory damages. Thus, with no other measure of damages available, the Court awarded nominal damages to the Company in the amount of $1 per Defendant.

Ravenswood Investment Company v. Winmill & Co., Inc.

Court of Chancery Dismisses Breach of Fiduciary Duty Claim as Duplicative of Breach of Contract Claim

By: Scott Waxman and Zack Sager

In MHS Capital LLC v. Goggin, the Delaware Court of Chancery granted a motion to dismiss a breach of fiduciary duty claim against the manager of a Delaware limited liability company because all of the manager’s conduct that could have formed the basis of such claim was covered by the duties of the manager delineated in the limited liability company agreement.  The Court also analyzed and dismissed claims for, among other things, fraud, breach of the implied contractual covenant of good faith and fair dealing, unjust enrichment, and misappropriation of trade secrets.

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CONTROLLING STOCKHOLDER CANNOT ADVANCE ITS OWN SELF-INTEREST AT EXPENSE OF MINORITY STOCKHOLDERS

By: C. J. Voss and Rich Minice

In Carr v. New Enterprise Associates, Inc., C.A. No. 20170381-AGB (Del. Ch. Mar. 26, 2018), the Delaware Court of Chancery, in denying in part and granting in part a motion to dismiss, reaffirmed the principle that a controlling stockholder, when acting outside its capacity as a stockholder, cannot use the corporation to advance the controlling stockholder’s self-interest at the expense of minority stockholders.  In the context of defendants’ motion to dismiss, the court found that it was reasonably conceivable that the controlling stockholder of American Cardiac Therapeutics, Inc. (“ACT”) and its conflicted board of directors had breached their duty of loyalty to ACT’s minority stockholders by approving a sale of a warrant to a third party that included an option to acquire ACT, allegedly at an unfairly low price, in order to incentivize the third party to also acquire and invest in the controlling stockholder’s other portfolio companies.

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Chancery Court Denies Motion to Dismiss Brought by Defendant Tesla Motors, Inc. After Concluding that Elon Musk is a Controlling Stockholder

By Holly Hatfield and Daisy Sexton

In In Re Tesla Motors, Inc. Stockholder Litigation, the Delaware Chancery Court denied Defendants’ motion to dismiss an action brought by plaintiffs (Tesla stockholders) against nominal Defendant Tesla Motors in connection with Tesla’s acquisition of SolarCity Corporation.  Plaintiffs alleged that Tesla’s board of directors breached their fiduciary duties by approving the acquisition of SolarCity, which benefitted SolarCity stakeholders but negatively affected Tesla stockholders.  SolarCity is a public Delaware corporation founded by Elon Musk and his cousins, Peter and Lyndon Rive.  Musk and his cousins sit on the SolarCity Board. Lyndon was SolarCity’s CEO and Peter was its CTO.

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Court of Chancery Holds That Plaintiff Failed to Meet Burden of Proof With Respect to Mistake-Based Reformation Claim

By: Scott Waxman and Tami Mack

In Richard B. Gamberg 2007 Family Trust v. United Restaurant Group, L.P., C.A. No. 10994-VCMR (Del. Ch. January 26, 2018), the Court of Chancery held that limited partner, Richard B. Gamberg 2007 Family Trust (the “Plaintiff”), failed to meet its burden of proof with respect to various claims against United Restaurant Group L.P. (the “Partnership”), Atlantic Coast Dining, Inc. (the “General Partner”), and the directors/shareholders of the General Partner (the “Shareholder Defendants”; together with the Partnership and the General Partner, the “Defendants”), which included a mistake-based reformation claim, among other breach of contract and breach of fiduciary duty claims.

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CHANCERY COURT NULLIFIES DISSOLUTION OF LIMITED LIABILITY COMPANIES FOR FAILURE TO SET ASIDE A RESERVE TO SATISFY KNOWN CLAIMS

By: Scott E. Waxman and Calvin D. Kennedy

In Kevin Capone and Steven Scheinman v. LDH Management Holdings LLC, et al., C.A. No. 11687-VCG (Del. Ch. April 25, 2018), the plaintiffs, Kevin Capone (“Capone”) and Steven Scheinman (“Scheinman”), and the defendants, LDH Management Holdings LLC (“Management Holdings”), LDHMH MM, LLC (together with Management Holdings, the “LLCs”), Castleton Commodities International LLC (f/k/a Louis Dreyfus Highbridge Energy LLC (“LDH”)) and certain members of the Board of Directors of LDH, each moved for summary judgment regarding the plaintiffs’ claim that the defendants violated Delaware law by cancelling the LLCs without setting aside a reserve for the plaintiffs’ breach of contract claims.  The court granted the plaintiffs’ motion for summary judgment and held that the defendants were aware of the plaintiffs’ non-frivolous claims for breach of contract against the LLCs and, therefore, the defendants acted in violation of Delaware law when they failed to create a reserve to cover the plaintiffs’ claims when the LLCs were dissolved.

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Chancery Court Limits Access to Books and Records Based on Stockholder’s Failure to State Purpose in Section 220 Demand

By: James S. Bruce and Taylor B. Bartholomew

In KT4 Partners LLC v. Palantir Technologies, Inc., C.A. No. 2017-0177-JRS (Del. Ch. Feb. 22, 2018), in a post-trial ruling, the Delaware Court of Chancery granted a stockholder limited rights to inspect a corporation’s books and records related to the stated purpose of investigating possible wrongdoing, but the Court denied the stockholder’s request to obtain other books and records related to the purpose of valuing its shares because its initial demand did not explicitly state a valuation purpose.

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PLAINTIFFS WERE UNABLE TO ROUSE SUPPORT FOR THEIR POSITION THAT A MINORITY STOCKHOLDER WAS A CONTROLLER AND BREACHED FIDUCIARY DUTIES BECAUSE THEY DID NOT PLEAD SUFFICIENT FACTS

By: Annette Becker and Rich Minice

In In re Rouse Properties, Inc. Fiduciary Litigation, C.A. No. 12194-VCS, the George Leon Family Trust and Dr. Robert A Corwin (the “Plaintiffs”) sought to recover damages on behalf of Rouse Properties Inc. (“Rouse”) stockholders, for breach of fiduciary duties and aiding and abetting breaches of fiduciary duties against Brookfield Asset Management Inc. (“Brookfield”) and five Rouse directors individually arising out of a July 2016 merger between two mall real estate holding companies (the “Merger”). The court dismissed all claims finding that Brookfield was not a minority controlling stockholder of Rouse and did not wield undue influence over the board of directors of Rouse in general or during Merger discussions and that the Plaintiffs failed to well plead that the stockholder vote approving the Merger was uninformed or coerced.

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Chancery Court Finds Credible Basis for Demand to Inspect Books and Records of UnitedHealth in connection with Possible Medicare Overbilling

By: David Forney and Joshua Haft

In In re UnitedHealth Group, Inc. Section 220 Litigation, Consolidated C.A. No. 2017-0681-TMR (Ch. Ct February 28, 2018) certain stockholders (“Plaintiffs”) of UnitedHealth Group, Inc. (“UnitedHealth”) sent a books and records inspection demand to UnitedHealth relying on a complaint in a type of whistleblower (qui tam) action alleging that UnitedHealth engaged in improper Medicare billing, United States ex rel. Poehling v. UnitedHealth Group, Inc. (the “Qui Tam Action”).  The Qui Tam Action was based in part on a 5-year investigation by the US Department of Justice (“DOJ”) and included depositions of 20 of UnitedHealth’s employees and production by UnitedHealth of over 600,000 documents. Plaintiffs made their demand in order to investigate mismanagement or misconduct, possible breaches of fiduciary duties and the independence and disinterestedness of the board. UnitedHealth rejected the demand and a trial was held on January 9, 2018.  UnitedHealth argued that Plaintiffs were not entitled to inspection of books and records because they lacked a credible basis to infer wrongdoing or mismanagement based on the Qui Tam Action and because the alleged activities of UnitedHealth were not illegal.  The Court found that Plaintiffs’ demand stated a proper purpose and a credible basis from which a court could infer mismanagement or wrongdoing.

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