The Delaware Law Series


Skye Mineral: Minority Investor “Blocking Rights” and Actual Control

Gail Weinstein is senior counsel and Warren S. de Wied and Erica Jaffe are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. de Wied, Ms. Jaffe, Brian T. Mangino, Shant P. Manoukian, and Bret T. Chrisope, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes The Perils of Small-Minority Controllers by Lucian Bebchuk and Kobi Kastiel (discussed on the Forum here).

In Skye Mineral Investors, LLC v. DXS Capital (U.S.) Limited (Feb. 24, 2020), the Delaware Court of Chancery found, at the pleading stage, that it was reasonably conceivable that the two key minority members of Skye Mineral Partners, LLC (“SMP”) had breached their fiduciary duties to SMP and the other members by intentionally using the contractual veto rights they had under SMP’s LLC Agreement to harm SMP and increase their own leverage. Also, the court found that members of the group that controlled these minority members, as well as certain affiliates of that group, may have aided and abetted the fiduciary breaches. In addition, the court found that one of these minority members and its authorized observer on the SMP board breached their confidentiality obligations by using information they learned, through the observation right, to advance the member’s interests at SMP’s expense.

The decision serves as an explicit reminder of the fiduciary and other obligations that LLC members and managers (and their affiliates) may have when the LLC agreement does not clearly and unambiguously provide otherwise. Further, the decision indicates that, under unusual circumstances, minority members may find themselves in the unexpected position of having fiduciary obligations as controllers–if their veto rights under the LLC agreement have put them in a position of “actual control” of the LLC (and particularly if they use that control to advance their own interests while harming the company).

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Federal Forum Selection Charter Provisions Validated by Delaware Supreme Court

William B. Chandler III, David Berger, and Brad Sorrels, are partners at Wilson Sonsini Goodrich & Rosati. This post is based on a WSGR memorandum by Mr. Chandler, Mr. Berger, Mr. Sorrels, and Andrew Berni. This post is part of the Delaware law series; links to other posts in the series are available here.

[On March 18, 2020] the Delaware Supreme Court issued an important en banc decision [1] upholding the right of Delaware corporations to adopt forum-selection provisions in their charters requiring claims under the Securities Act of 1933 (the “’33 Act”) to be brought in federal court (the “Federal Forum Provisions”). The Supreme Court’s decision provides a critical tool for pre-IPO companies to address the increase in the number of lawsuits brought in state court asserting claims under Section 11 of the ’33 Act challenging disclosures in their registration statements. Prior to this ruling, many such claims were brought in state courts which had led to inconsistent and unpredictable rulings. As a result, D&O insurance premiums for such claims have increased dramatically in recent years.

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The Long Rise and Quick Fall of Appraisal Arbitrage

Wei Jiang is the Arthur F. Burns Professor of Free and Competitive Enterprise at Columbia Business School; Tao Li is Assistant Professor of Finance at University of Florida Warrington College of Business; and Randall S. Thomas is John S. Beasley II Chair in Law and Business at Vanderbilt Law School. This post is based on their recent paper, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Using the Deal Price for Determining “Fair Value” in Appraisal Proceedings (discussed on the Forum here) and Appraisal After Dell, both by Guhan Subramanian.

Appraisal is a legislatively created right for shareholders to seek a judicial determination of the fair value of their shares that they choose not to surrender in a takeover or another change-of-control transaction. For many decades, appraisal was a little used, and even frequently maligned, corporate law remedy. Beginning at the turn of the 21st century, this all changed when a group of financial investors, especially some specialized hedge funds, began filing appraisal cases to garner high returns from litigation rather than seek remedy on their pre-existing investment. Appraisal arbitrage, as it became known, grew rapidly in popularity.

Appraisal arbitrage’s success soon attracted negative attention. In 2016, the Delaware legislature amended its appraisal statute to address two major criticisms of the existing system by eliminating small shareholders’ appraisal rights and by permitting companies to pre-pay merger consideration to appraisal petitioners to avoid paying interest at a lucrative rate – 5% above the federal discount rate. In 2017, the Delaware Supreme Court issued two important decisions on DFC Global and Dell, both assigning more weights to deal prices as the primary measure of fair value. Appraisal filings plummeted soon thereafter.

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2019 Developments in Securities and M&A Litigation

Roger CooperJared Gerber, and Mark McDonald are partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary memorandum by Mr. Cooper, Mr. Gerber, Mr. McDonald, Ryan Madden, and Suzannah Golick.

Overview

In 2019, the Supreme Court issued an important securities law decision in Lorenzo v. SEC, which clarified the scope of “scheme liability” under Rule 10b-5(a) and (c). However, the Supreme Court’s year was noteworthy more for the cases the Court declined to decide than for the cases it did decide. The Court declined to rule on several significant issues arising from the Ninth Circuit, including whether plaintiffs must show that the defendant acted with scienter when bringing claims under Section 14(e), whether foreign issuers can face liability with respect to unsponsored American Depositary Receipts under Morrison, and the standard for establishing loss causation.

The circuit and district courts also addressed several contested securities laws topics, including a significant ruling from the Tenth Circuit in SEC v. Scoville, which held that the Dodd-Frank Act permits the SEC to bring claims based on sales of securities that do not constitute domestic transactions within the meaning of Morrison. The Second Circuit also found limits to the extraterritorial reach of the CEA in Prime International Trading v. BP P.L.C. when the transactions at issue were “predominantly
foreign.”

With respect to M&A litigation, the Delaware Supreme Court continued to clarify its jurisprudence with respect to appraisal methodology as well as the protection MFW affords to controlled transactions. The Court also released important opinions pertaining to oversight duties for boards of directors and the fiduciary duties of activist investors. The Delaware Court of Chancery continued to see a rise in litigation pertaining to books and records demands under Section 220. It also issued decisions reflecting its continued strict enforcement of the plain language of provisions in merger agreements.

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Appraisal and Merger Synergies—Right to a Refund on Prepayments

Gail Weinstein is senior counsel, and Brian T. Mangino and Amber Banks (Meek) are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Mangino, Ms. Banks, David L. Shaw. Randi Lally, and Shant P. Manoukian. This post is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Using the Deal Price for Determining “Fair Value” in Appraisal Proceedings (discussed on the Forum here) and Appraisal After Dell, both by Guhan Subramanian.

In In Re Appraisal of Panera Bread Company (Dec. 31, 2019), the Delaware Court of Chancery found that the sale process relating to the $7.5 billion acquisition of Panera Bread Company by JAB Holdings B.V. was sufficient for the court to rely on the deal price to determine appraised fair value. The court also found that JAB provided sufficient evidence for the court to deduct from the deal price the value of certain expected merger synergies (pursuant to the statutory mandate to exclude from fair value any value “arising from the merger itself”). The appraisal result was about 3.7% below the deal price. Finally, in a matter of first impression, the court ruled that JAB–which had prepaid the appraisal claimants based on the full deal price, was not entitled under the appraisal statute to a refund on the prepayment.

Key Points

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Directors’ Fiduciary Duties: Back to Delaware Law Basics

Peter A. AtkinsMarc S. Gerber, and Edward B. Micheletti are partners at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on a Skadden memorandum by Mr. Atkins, Mr. Gerber, Mr. Micheletti, Robert S. Saunders, and Mary T. Reale. This post is part of the Delaware law series; links to other posts in the series are available here.

The dawn of a new decade brings with it the certainty of ongoing challenges to the conduct of public company directors based on alleged breaches of fiduciary duty.

This post is a brief reminder for directors of Delaware corporations (and of corporations organized in states that generally follow Delaware law in this area) of the basic fiduciary duty rules that govern their conduct. If these rules are understood and followed, directors should be able to avoid fiduciary duty breaches and protect themselves from exposure to potential liability. These rules and available protections, discussed below, encompass:

  • the basic fiduciary duties (care and loyalty, including good faith, oversight and disclosure),
  • key director attributes (independence and disinterestedness, and appreciation of “red flags”),
  • the importance of process (including asking the right questions and keeping a good record),
  • the core standard for judging director conduct (the business judgment rule), and
  • key Delaware law protections (including good faith reliance on others and exculpatory charter provisions).

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Corporate Opportunity Doctrine: Litigation Continues into 2020

Nate Emeritz is Of Counsel and Brian Currie is an associate at Wilson Sonsini Goodrich & Rosati. This post is based on their WSGR memorandum and is part of the Delaware law series; links to other posts in the series are available here.

In a short order from the Delaware Court of Chancery, Vice Chancellor Kathaleen McCormick held that a former director may have usurped a corporate opportunity by successfully bidding against his company for a contract to operate a local public access television channel. Leased Access Preservation Assoc. v. Thomas, C.A. No. 2019-0310-KSJM (Del. Ch. Jan 8, 2020) (ORDER). This decision addressed the scope of what constitutes a corporate opportunity and when a director is acting in a fiduciary capacity, each for purposes of the corporate opportunity doctrine. In doing so, this litigation picked up on issues also addressed in several cases in 2019 and suggests that the corporate opportunity doctrine may continue to be an important topic in Delaware corporate law in 2020.

Leased Access case

Leased Access, a case about a Delaware non-profit, non-stock corporation (Leased Access Preservation Association or “LAPA”) that had operated a local public access television channel on a yearly basis for five years, marks the first foray by the Court of Chancery into the corporate opportunity doctrine in 2020. In that case, when proposals were solicited for a new contract on the television channel, one of LAPA’s directors (who later claimed to have already resigned) secretly submitted a competing bid and allegedly disseminated negative information about LAPA’s operational practices, based on information he had learned as a director. An entity controlled by the director was ultimately awarded the contract. As described by the Delaware Supreme Court, the corporate opportunity doctrine “holds that a corporate officer or director may not take a business opportunity for his own if: (1) the corporation is financially able to exploit the opportunity; (2) the opportunity is within the corporation’s line of business; (3) the corporation has an interest or expectancy in the opportunity; and (4) by taking the opportunity for his own, the corporate fiduciary will thereby be placed in a position inimical to his duties to the corporation.” Broz v. Cellular Info. Sys., 673 A.2d 148 (Del. 1996).

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Delaware’s Position on Director Independence: a Change in Approach?

Gail Weinstein is senior counsel and Steven Epstein and Warren S. de Wied are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Epstein, Mr. de Wied, Brian T. Mangino,  Andrew J. Colosimo, and David L. Shaw, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

In McElrath v. Kalanick (Jan. 13, 2020), the Delaware Supreme Court upheld the Court of Chancery’s decision that dismissed a derivative suit brought by a stockholder of Uber Technologies, Inc. (“Uber”) for damages arising from Uber’s 2016 acquisition of Ottomotto LLC (“Otto”). The Supreme Court agreed with the Court of Chancery’s determination that a majority of the Uber directors in office at the time the complaint was filed were independent and had not acted in bad faith–and, therefore, that pre-suit demand on the board to bring the litigation would not have been “futile” and so was not excused.
Key Point

  • The decision, in our view, does not necessarily suggest a change in the Delaware courts’ recent approach in determining director independence in the demand futility context. Delaware has consistently applied long-established principles for determining director independence. In recent years, however, when applying those principles in the demand futility context, the courts have appeared to more readily find non-independence than they had previously. Some commentators have suggested that the decision signals a return to the seemingly stronger presumption of independence of the past. While that is possible, we do not read the decision that way (as discussed below).
  • Separately, the decision reinforces that there continues to be a high bar to a finding of bad faith by directors–and that this, in combination with exculpation provisions, continues to make it highly unlikely that independent directors would have personal liability for alleged fiduciary breaches except in the most egregious cases.

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Actionable Claim to Inspect Books and Records

Jason M. Halper and Ellen Holloman are partners, and Sara Bussiere is an associate at Cadwalader, Wickersham & Taft LLP.  This post is based on their Cadwalader memorandum and is part of the Delaware law series; links to other posts in the series are available here.

In Lebanon County Employees’ Retirement Fund, et al. v. AmerisourceBergen Corporation, the Delaware Court of Chancery ordered the inspection of the books and records of AmerisourceBergen Corporation, one of the leading opioid distributors in the country, for the purpose of investigating potential mismanagement or breaches of fiduciary duty in connection with the company’s distribution of opioids. In his decision, Vice Chancellor J. Travis Laster confirmed that stockholders are not required to show that the misconduct central to the investigation supports an actionable claim in order to meet their low burden to enforce inspection rights under Section 220 of the Delaware General Corporation Law. The decision also reinforced that, in appropriate circumstances, the Court will allow stockholders to inspect both board-level documents reflecting the directors’ decisions at formal board meetings and less formal communications by and among directors, officers, and senior-level managers. This decision is notable because the Court rejected the company’s efforts to impose heightened burdens on stockholders seeking to discover additional information about the types of books and records a company may or may not have, and in what formats those records exist. This decision also serves as a reminder to boards considering inspection demands that stockholders bear a low burden to show they are entitled to enforce their inspection rights under Delaware law, and if stockholders meet clear this threshold—which is seemingly easier in the context of publicly scrutinized events—Delaware courts are increasingly likely to find that stockholders are entitled to inspect minutes and other sources of information. Companies confronted with inspection demands should be strategic in what demands to oppose, and consider whether negotiation with the stockholder ultimately may produce a more favorable outcome than litigating the issue in court.

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Core Principles of Exculpation and Director Independence

William SavittRyan A. McLeod and Anitha Reddy are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here); and Monetary Liability for Breach of the Duty of Care? by Holger Spamann (discussed on the Forum here).

The Delaware Supreme Court recently reaffirmed important principles defining the scope of director liability for derivative claims. McElrath v. Kalanick, No 181, 2019 (Del. Jan. 13, 2020).

In 2016, to jumpstart its self-driving car program, Uber purchased Ottomotto LLC and hired employees with relevant technical expertise away from Google. When it later came to light that the new hires had misappropriated proprietary Google information, Uber fired the key new employee and paid $245 million in stock to settle Google’s claims. A stockholder plaintiff then sued Uber’s board, alleging that the directors breached their duties by approving the Ottomotto transaction. In a carefully reasoned opinion upholding the dismissal of the suit, the Supreme Court reaffirmed two important pleading requirements that shield directors from unsubstantiated derivative litigation:

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