In CertiSign Holding, Inc. v. Sergio Kulikovsky, C.A. No. 12055-VCS, the Court found that Sergio Kulikovsky (“Kulikovsky”), a former director of CertiSign Holding, Inc. (“CertiSign”), had breached his fiduciary duty of loyalty to CertiSign by actively sabotaging corporate self-help efforts in a bid to advance his own personal objectives. The Court also denied Kulikovsky’s counterclaims for judicial validation of certain stock option grants and the assumption by CertiSign of a debt owed to Kulikovsky, and awarded Certisign damages in the amount of $390,455.20 for the “legal fees and expenses incurred by CertiSign in connection with its efforts to remedy its defective capitalization and board issues.”
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.
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 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.
In Wilkin v. Narachi, et al., and Orexigen Therapeutics, Inc., Civil Action No. 12412-VCMR (Del. Ch. February 28, 2018), the Delaware Court of Chancery granted a motion to dismiss brought by defendants (“Defendants”), directors and officers of biopharmaceutical company Orexigen Therapeutics, Inc. (“Orexigen”), for failure to plead demand futility under Court of Chancery Rule 23.1. The Court ruled that the plaintiff, a stockholder of Orexigen (“Plaintiff”), did not plead sufficient facts to show that a substantial likelihood of liability prevented the directors from exercising independent and disinterested business judgment when considering a demand to bring a lawsuit on behalf of the corporation.
In Lavin v. West Corporation, C.A. No. 2017-0547-JRS (Del. Ch. December 29, 2017), the Court of Chancery held that stockholder plaintiff Mark Lavin (“Lavin”) had adequately demonstrated a credible basis from which the Court could infer that wrongdoing had occurred regarding the merger of West Corporation (the “Company”) and Apollo Global Management (“Apollo”) in support of Lavin’s Section 220 demand for inspection, and that a Corwin defense (that the transaction at issue was approved by a majority of disinterested and informed stockholders) is not a bar to an otherwise properly supported Section 220 demand for inspection.
By: Scott E. Waxman and Daisy Sexton
In Brett Kandell v. Dror Niv et al., the Delaware Chancery Court denied in part and granted in part a motion to dismiss a derivative action brought by a stockholder (“Plaintiff”) against nominal defendant FXCM, Inc. (“FXCM” or “the Company”), a foreign exchange (“FX”) broker. The claim was brought against FXCM directors (“Defendants”) for losses associated with the “Flash Crash” in the value of the euro relative to the Swiss franc, which happened when the Swiss decoupled the two currencies. As a result of these huge losses, FXCM had to obtain a loan under onerous conditions. Two main causes of action were asserted: (1) that the directors’ ability to exercise business judgment with respect to the Flash Crash was impaired, and (2) that the directors knowingly violated 17 C.F.R. § 5.16 (“Regulation 5.16”) which prohibits foreign exchange traders from representing that they will limit clients’ trading losses. Plaintiff did not make a demand on the company prior to bringing suit.
Delaware Court Of Chancery Ruling Provides a Cautionary Tale for Investment Fund Directors Seeking to Monetize Their Investment
In The Frederick Hsu Living Trust v. ODN Holding Corp., et al., one of the founders of ODN Holding Corporation (the “Company”) filed suit against the controlling stockholder, the board and certain officers of the Company for cash redemptions of preferred stock allegedly made in violation of statutory and common law instead of using the Company’s cash to maximize the value of the Company for the long term benefit of all stockholders. The Delaware Court of Chancery granted defendants’ motions to dismiss claims of waste and unlawful redemption. However, the Court of Chancery denied defendants’ motions to dismiss claims of breach of fiduciary duty, aiding and abetting a breach of fiduciary duty, and unjust enrichment finding that the allegations of the Plaintiff supported a reasonable inference that the entire fairness standard would apply and that individual defendants may have acted in bad faith.
In Ryan v. Armstrong, et al., C.A. No. 12717-VCG (Del. Ch. May 15, 2017), the Delaware Chancery Court dismissed the derivative action brought by a Plaintiff-shareholder (“Plaintiff”) against specified members of the board of directors (“Defendants”) of nominal defendant The Williams Companies (“Williams”). Plaintiff brought his claim against the Defendants without first demanding that the board pursue an action following Williams’ decision to allegedly undertake defensive measures against a takeover. The court granted Defendants’ motion to dismiss holding that Plaintiff failed to plead facts demonstrating that an exception to the demand requirement of Court of Chancery Rule 23.1 applied.
In Rodgers v. Cypress Semiconductor Corporation, C.A. No. 2017-0070-AGB (Del. Ch. April 17, 2017), the Court of Chancery held that shareholder plaintiff T.J. Rodgers (“Rodgers”) had established several proper purposes for his demand to inspect certain books and records of Cypress Semiconductor Corporation (the “Company”), along with a credible basis to infer wrongdoing by at least one of the Company’s directors. The Court granted Rodgers’ Section 220 action and directed the parties to meet and submit an order for production of all responsive documents.
In In re Saba Software, Inc. Stockholder Litigation, C.A. No. 10697-VCS (Del. Ch. Mar. 31, 2017, revised Apr. 11, 2017), the Delaware Court of Chancery held that the board of Saba Software, Inc. could not invoke the business judgment rule under the Corwin doctrine in response to a fiduciary challenge arising from Saba’s acquisition by Vector Capital Management, L.P. According to the Court, plaintiff pled facts which supported a reasonable inference that the stockholder vote approving the acquisition was neither fully-informed nor uncoerced. The Court also denied defendants’ motion to dismiss plaintiff’s claims that the Saba board breached its duty of loyalty and engaged in acts of bad faith by rushing the sales process, refusing to consider alternatives to the merger and granting itself substantial equity awards.
The Court of Chancery granted a motion to dismiss a shareholder derivative action brought against the board of directors of UPS for breach of their fiduciary duty of loyalty in which it was alleged that the board failed to monitor UPS’s compliance with laws governing the transportation and delivery of cigarettes, resulting in the government seeking approximately $180 million in a pending enforcement action against UPS. In ruling on the motion, the Court held that the plaintiffs did not adequately plead facts to support their contention that making a demand on the board of directors to take corrective action or pursue the claim would be futile, which is a prerequisite to a shareholder derivative action.