In Shareholder Representative Services LLC v. RSI Holdco, LLC, C.A. No. 2018-0517-KSJM (Del. Ch. May 22, 2019), the Court of Chancery held that the buyer could not seek remedy outside of the scope of a merger agreement from the sellers’ representative without bringing in all sellers as parties to the action because the representative’s authority was limited to matters relating to or arising under the four corners of that agreement. The Court also denied the representative’s motion to dismiss the buyer’s unjust enrichment claim because the buyer properly alleged that the contract arose from sellers’ wrongdoing.Read More
In Shareholder Representative Services LLC v. RSI Holdco, LLC, C.A. No. 2018-0517-KSJM (Del Ch. May 29, 2019) the Court of Chancery held that a privileged communications provision in a merger agreement protected the pre-merger communications between the seller and the seller’s legal counsel in spite of the buyer’s insistence that the privilege had transferred in the merger or had been waived.Read More
In a landmark decision, a Delaware court has, for what is widely believed to be the first time ever, found that a material adverse effect actually occurred in an acquisition transaction, giving the buyer a right to terminate the pending transaction. In Akorn, Inc. v. Fresenius Kabi AG, the Delaware Court of Chancery (the “Court”) held, following a trial, that the buyer properly terminated the parties’ merger agreement, due to such a material adverse effect between signing and closing, under the terms of the agreement and the pertinent Delaware case law. Unlike prior decisions rejecting buyer material adverse effect claims, the Court found that a pre-closing decline in the business of the target – Akorn – was not merely a “cyclical trend” and was likely to have a post-closing, durationally-significant effect that was “material when viewed from the longer-term perspective of a reasonable acquiror.” Although groundbreaking, the Akorn decision reflects that the Delaware courts will still approach the question of whether an MAE has occurred on a case-by-case basis and does not establish a particular “bright line” test.
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.
In Nguyen v. View, Inc. (C.A. No. 11138-VCS (Del Ch. June 6, 2017), the Delaware Chancery Court denied defendant View Inc.’s (“View”) motion to dismiss a suit brought by its Paul Nguyen, a majority common stockholder of View, seeking a declaration in accordance with 8 Del. C. § 205, that View’s attempts to validate invalid rounds of financing were improper. The Court held that a stockholder’s rejection of a corporation’s proposal and a decision to proceed with a deliberately unauthorized corporate act does not qualify as a “defective corporate act” that can subsequently be ratified under 8 Del. C. § 204.
In Nguyen, Paul Nguyen was the founder of View.—a corporation that sold windows with manually- and electronically-adjustable lighting properties—and served as both its President and Chairman of its Board. In 2007, View entered into a preferred stock financing round with two venture capital funds (the “Series A Financing”). Under the Series A Financing agreement, Nguyen would step down as the company’s CEO, but would still retain seventy percent of View’s outstanding common stock. The parties also drafted a new voting agreement that altered View’s governance structure. This agreement established a five-person Board of Directors, composed of two seats controlled by each venture fund and one controlled by Nguyen. View then filed an Amended and Restated Certificate of Incorporation that provided the venture funds with the rights to veto or approve many of View’s corporate acts. It also provided Nguyen with the protection of a class vote provision that any amendment to the certificate of incorporation changing the rights of the common stock and any changes to the voting agreement relating to Nguyen’s ability to approve changes to the size of the board of directors and to fill a seat on the board must be approved by a majority of the common stock outstanding.
In 2009, following the appointment of a new CEO, View terminated Nguyen’s employment and began maneuvering to push him out of leadership on its Board. Nguyen, however, asserted that his status as majority common stockholder meant that his removal violated both the certificate of incorporation and the voting agreement. View and Nguyen took their dispute to mediation and eventually came to a settlement agreement that included a stockholder consent signed by Nguyen that would allow the company to pursue new financing agreements (the “Series B Financing”). The Series B Financing as proposed would eliminate Nguyen’s rights to approve any amendments to the certificate of incorporation or voting agreement, his position as Chairman, and his ability to fill a Board seat. The settlement agreement, however, contained a seven-day rescission period for either party. After further review of the Series B Financing, Nguyen objected to the change to his rights as a stockholder and sent a notice of rescission of the settlement agreement and the stockholder consent to View within the seven-day window. View, however, had already closed the Series B Financing before the rescission window elapsed. Nguyen filed suit to challenge the validity of the Series B financing, and the parties agreed to submit the matter to arbitration. During arbitration, View entered into subsequent financing rounds, raising over $500 million. Eventually, the arbitrator ruled that Nguyen had validly rescinded the settlement agreement and stockholder consent. As a result, the Series B Financing and subsequent financing rounds became void and invalid.
Because View’s reformed capital structure hinged on the Series B Financing, the Series A Financing stockholders pursued alternative methods to ratify the financing. They converted their preferred shares to common stock to displace Nguyen as the majority common stockholder; subsequently, they ratified the Series B financing the arbitrator ruled to be invalid, replaced the existing voting agreement with a new one that created an eleven-member Board, and removed Nguyen from the Board. View later discovered that it had ratified these amendments improperly and corrected its ratifications. Nguyen filed suit under 8 Del. C. § 205, alleging that the ratifications View adopted were improper. View subsequently filed a motion to dismiss, stating that Nguyen had not pled facts that could support his § 205 claim.
The court denied View’s motion to dismiss. The court first qualified that in order to determine whether View’s ratifications were proper under Section 204, it would need to determine whether the acts needing ratification qualified as “defective corporate acts” under Section 204. In examining Section 204, the court concluded that View’s amendments did not qualify as “defective corporate acts.” The court noted that Section 204 provides that any “defective corporate acts that a corporation purports to ratify must be within the corporation’s power ‘at the time such act[s] [were] purportedly taken.’” (emphasis in original). Therefore, the court reasoned that because View’s voting agreement and certificate of incorporation required the majority stockholder’s consent to make any corporate actions valid as a matter of law, Nguyen’s refusal to give his consent undercut the legitimacy of the corporation’s ratifications. The court explained that “[t]he reason the Series B Financing was declared void was not that View failed to comply with the Delaware General Corporation Law or its own governance documents in securing the stockholders’ approval of the transaction; the transaction was void because the majority common stockholder deliberately rejected it.” (emphasis added). The court distinguished a stockholder’s “rejection” of a corporate proposal from a mere “failure” of authorization, and held that allowing ratification of the former is not contemplated by Section 204.
View alternatively argued that Nguyen’s refusal to consent did not prevent the Series A holders from later converting their shares to common stock and ratifying the Series B Financing since they could have done so at the time. The court rejected this position, finding that it would undermine the power of a stockholder’s “no” vote. Finally, the court stated that Section 204 could not be used as a “license to cure just any defect” nor “to ‘backdate’ an act that did occur but that the corporation wishes had occurred as of an earlier date.” Therefore, View could not use Section 204 to backdate its conversion of preferred stock to common stock and avoid Nguyen’s consent for ratification of the Series B financing.
The court subsequently denied View’s motion for a reargument under Court of Chancery Rule 59(f).
In Merinoff v. Empire Merchants, C.A. No. 12920-VCS (Del. Ch. Feb. 2, 2017), the Court of Chancery held that a forum selection clause in the LLC agreement of Empire Merchants, LLC (“Empire”) precluded an action by the managers and officers of Empire to obtain advancement of legal fees from being brought in the Delaware Court of Chancery.
Plaintiff officers and managers of Empire were defendants in a separate action brought by Empire in New York alleging that they carried out a massive and long running bootlegging scheme to illegally divert wine and spirits from Maryland into New York. Plaintiffs filed a claim in the Delaware Court of Chancery asserting that Empire’s LLC Agreement entitled them to advancement of legal fees that they would incur in defending that action. Empire asserted that its LLC agreement required such claims to be brought in New York and moved to dismiss under Court of Chancery Rule 12(b)(3) for improper venue.
The Court first recited the plain language of Empire’s LLC agreement, which provided that “any suit, action, or other legal proceeding arising out of this Agreement shall be brought in the United States District Court for the Southern District of New York or in any courts of the state of New York sitting in the Borough of Manhattan….” It further included a carve-out stating that “[n]otwithstanding the foregoing, any legal proceeding arising out of this Agreement which, under [Delaware’s Limited Liability Company] Act or, to the extent made applicable to the Company pursuant to this Agreement, the DGCL, is required to be brought in the Delaware Court of Chancery may only be brought in the Delaware Court of Chancery….”
The Court then explained that the Delaware Limited Liability Company Act does not contain any provisions regarding venue for claims relating to advancement of fees, but the DGCL, in § 145, states that the Delaware Court of Chancery shall have “exclusive jurisdiction” to hear such claims with respect to corporations. Plaintiffs argued that since the Empire LLC agreement incorporated certain terms from the DGCL, the carve-out in the Empire LLC agreement applied and they were required to bring this action in Delaware.
The Court rejected plaintiff’s arguments for two reasons. First, the portions of the DGCL incorporated into Empire’s LLC agreement related only to the standards for duties owed by managers and officers to Empire, not to advancement of fees. Second, even if the DGCL were applicable to plaintiff’s advancement claims, the statutory grant of “exclusive jurisdiction” to the Delaware Court of Chancery merely allocates jurisdiction among the Delaware courts, it does not constitute a “claim against the world that no court outside of Delaware can exercise jurisdiction….” Because this action therefore could have been brought elsewhere, it did not fall into the carve-out, which only captures actions “required” to be brought in Delaware. Thus the Court granted Empire’s motion to dismiss for improper venue.
In FdG Logistics v. A&R Logistics, C.A. No. 9706-CB (Del. Ch. Feb. 23, 2016), the Court of Chancery held that a non-reliance provision contained in a merger agreement was ineffective to bar a buyer’s fraud claims based on extra-contractual statements made during the due diligence and negotiation process because the non-reliance provision was formulated solely as a limitation on the seller’s representations and warranties. According to the Court, for a non-reliance provision to be effective against a buyer, it must be formulated as an affirmative promise by the buyer that it did not rely on any extra-contractual statements made by the seller during the sales process. The decision clarifies the Court of Chancery’s 2015 decision in Prairie Capital III, L.P. v. Double E Holding Corp., C.A. No. 10127-VCL (Del. Ch. Nov. 24, 2015) in which the Court emphasized that “no magic words” are required for a non-reliance provision to be effective.