The Delaware Law Series


Delaware Decision Deals with Director Independence

Gail Weinstein is senior counsel, and Steven J. Steinman and Brian T. Mangino are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Steinman, Mr. Mangino, Andrew J. Colosimo, Mark H. Lucas, and Erica Jaffe, 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).

BGC Partners, Inc. Derivative Litigation (Sept. 20, 2021) involved a merger between entities that were controlled by the same person, Howard Lutnick, through his control of Cantor Fitzgerald, L.P. (“Cantor”). Lutnick had a far larger economic interest in the target company, Berkeley Point Financial LLC (“Berkeley Point”), than in the acquiring company, BGC Partners, Inc. (“BGC”). The plaintiffs claimed that he therefore caused BGC to overpay for Berkeley Point (receiving himself 42% of the alleged overpayment, which amounted to $125 million, at the expense of the other BGC stockholders). The transaction was approved by a special committee of BGC’s four outside directors, after months of negotiation with BGC. (BGC’s minority stockholders did not vote on the transaction.) The plaintiffs sued Lutnick, Cantor, and BGC’s directors for breach of fiduciary duties in improperly approving the related-party transaction.

The court found, despite evidence that it characterized as “not overwhelming,” that two of the outside directors may not have been independent of Lutnick. As a result, the court held that: (i) the plaintiffs were excused from not having made a litigation demand on the board to bring the litigation (as demand would have been futile); (ii) the burden of proof under entire fairness review would not shift to the plaintiffs (as the transaction was not approved by a special committee comprised of a majority of independent directors); and (iii) the plaintiffs had validly pled a non-exculpated fiduciary claim against one of the non-independent directors (as that director may have taken actions that furthered Lutnick’s self-interest, violating the duty of loyalty).

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Special Committee Report

Gregory Gooding, William Regner and Jeffrey Rosen are partners at Debevoise & Plimpton LLP. This post is based on a Debevoise memorandum by Mr. Gooding, Mr. Regner, Mr. Rosen, Emily Huang, Maeve O’Connor, and Sue Meng, 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).

This post surveys corporate transactions announced during the period from January through June 2021 that used special committees to manage conflicts and key Delaware judicial decisions during this period ruling on the effectiveness of such committees. While corporate transactional activity during the first half of 2021 may be remembered more for SPACs, cryptocurrencies and meme stocks, there continued to be a significant number of conflicted transactions and the Delaware courts continued to refine the boundaries of Delaware law involving the use of special committees.

Special Committee Independence: How Close is Too Close

Once a decision has been made to form a special committee, the most important question, and sometimes a fraught one, is which directors are sufficiently independent of the interested stockholder to effectively serve on that committee. Delaware case law is replete with examples of committees whose effectiveness has been challenged because one or more members allegedly lacked independence, in many cases as a result of social or business connections with the interested stockholder. However, a recent Delaware Court of Chancery decision may signal a willingness of the Delaware courts to apply closer scrutiny to such allegations.

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Chancery Court Decision on the “Effect of Termination” Provision

Gail Weinstein is senior counsel, and Amber Banks (Meek) and Maxwell Yim are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Ms. Banks, Mr. Yim, Andrea Gede-Lange, 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 Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? by John C. Coates, Darius Palia, and Ge Wu (discussed on the Forum here); and Allocating Risk Through Contract: Evidence from M&A and Policy Implications by John C. Coates, IV (discussed on the Forum here).

The Delaware Court of Chancery’s recent decision in Yatra Online v. Ebix (Aug. 30, 2021) serves as a reminder that, under the “Effect of Termination” provision in most merger agreements, a party’s termination of the agreement extinguishes all liability of both parties for pre-termination breaches of the agreement, except as the parties may have otherwise specifically provided in the agreement. The Ebix case illustrates that, depending on how the parties have drafted the provision, a party can be left with no remedy for the willful breaches and wrongful failure to close of the other party.

Ebix, Inc. allegedly had a change of heart about proceeding with its agreed acquisition of Yatra Online, Inc. after the deal became less attractive to Ebix when the COVID-19 pandemic emerged. Allegedly, Ebix then blatantly breached its representations and covenants in the Merger Agreement and “strung along” Yatra with pretextual delays while in fact Ebix never intended to close. Yatra ultimately became “fed up” with Ebix’s misconduct, and, when several renegotiated end dates had passed with no sign that Ebix intended ever to close, Yatra sued Ebix for damages and exercised its right to terminate the Merger Agreement. The court held, however, that Yatra had no remedy because it had terminated the Merger Agreement and the Effect of Termination provision, as drafted, extinguished liability for pre-termination breaches without any carveout for liability for willful breaches.

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Delaware Supreme Court Announces New Demand Futility Test

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.

In what promises to be a landmark decision, the Delaware Supreme Court last week reframed the rules governing derivative litigation. United Food & Commercial Workers Union v. Zuckerberg, No. 404, 2020 (Del. Sept. 23, 2021).

A Facebook stockholder sued current and former directors to recover costs the company had incurred in connection with a proposed stock reclassification. The Court of Chancery dismissed the suit, finding that the plaintiff had failed to establish that at least half of the current directors were incapable of independently evaluating whether to pursue the suit.

The Delaware Supreme Court affirmed. Writing for the unanimous Court, Justice Montgomery-Reeves adopted a new test to determine when a stockholder will be permitted to press corporate claims over the board’s opposition. The Court emphasized that “the demand-futility analysis provides an important doctrinal check that ensures the board is not improperly deprived of its decision-making authority.” The essential inquiry is thus whether “there is reason to doubt that the directors would be able to bring their impartial business judgment to bear on a litigation demand” by a stockholder. When a corporation’s charter exculpates directors from liability for breach of care claims, such claims “no longer pose a threat that neutralizes director discretion.” Accordingly, the Court held that directors are not disabled from impartially considering a demand simply because the proposed complaint alleges that they breached their duty of care.

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Delaware Supreme Court Eliminates “Dual-Natured” Direct and Derivative Claim

William Savitt and Ryan A. McLeod, 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.

In a carefully reasoned decision, the Delaware Supreme Court this week overruled a 15-year precedent that had permitted minority stockholders to pursue classically derivative dilution claims directly against controlling stockholders. Brookfield Asset Management, Inc. v. Rosson, No. 406, 2020 (Del. Sept. 20, 2021).

The case concerned a private placement of TerraForm Power’s common stock to its controlling stockholder, Brookfield Asset Management, which TerraForm’s minority stockholders alleged was underpriced and dilutive. TerraForm was thereafter merged out of existence. Defendants moved to dismiss, arguing that the claims were derivative and that plaintiffs’ standing to prosecute derivative claims was extinguished by the merger. The Court of Chancery recognized that such “overpayment” claims are generally considered derivative, but nevertheless sustained the complaint on the basis of a 2006 decision that had concluded such claims were both derivative and direct where the transaction allegedly benefitted a controlling stockholder at the expense of the minority.

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Boeing’s MAX Woes Reach the Boardroom

Edward D. Herlihy and William Savitt 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 Monetary Liability for Breach of the Duty of Care? by Holger Spamann (discussed on the Forum here).

In an important decision this week, the Delaware Court of Chancery permitted a Caremark duty-of-oversight claim to proceed against the directors of the Boeing Company. Stockholder plaintiffs sued Boeing’s board, seeking to recover costs and economic losses associated with the crash of two 737 MAX jetliners. The plaintiffs’ complaint alleged that the directors failed to monitor aircraft safety before the crashes and then failed to respond to known safety risks after the first crash. The lawsuit seeks to hold the directors liable for the resulting loss of “billions of dollars in value.”

The court denied the directors’ motion to dismiss. The court first concluded that the pleaded facts described a board that “complete[ly] fail[ed] to establish a reporting system for airplane safety.” Emphasizing that meeting minutes gave little sign of director engagement with safety issues, the court credited allegations that the board had no committee charged with direct responsibility to monitor airplane safety, seldom discussed safety, and had no protocols requiring management to apprise the board of safety issues.

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Three Opinions on Fraud on the Board

Nathaniel J. Stuhlmiller is a director and Brian T.M. Mammarella is an associate at Richards, Layton & Finger. This post is based on their Richards, Layton & Finger memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

In a footnote in a two-page order issued in 2018, the Delaware Supreme Court quietly reminded corporate law practitioners that, per the 1989 case of Mills Acquisition v. Macmillan, a complaint seeking post-closing Revlon damages can survive a motion to dismiss without pleading nonexculpated breaches of fiduciary duty by a majority of directors so long as a single conflicted fiduciary deceived the entire board. See Kahn v. Stern, 183 A.3d 715 (Del. 2018) (TABLE). In the three years that followed, this “fraud-on-the-board” theory of liability has received long-form discussion in at least eight published Delaware opinions and evolved into a Swiss Army knife for stockholder-plaintiffs—indeed, Delaware courts have recently applied the once-obscure theory to serve at least three distinct doctrinal ends. This article describes, at a high level, what fraud on the board is by pinpointing the various doctrinal roles it has played in three recent opinions issued by the Delaware Court of Chancery.

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Delaware and New York Part Ways on Treatment of Future Affiliates Covered by Contract Restrictions

Daniel E. Wolf and Jonathan L. Davis are partners at Kirkland & Ellis LLP. This post is based on their Kirkland memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

In an earlier note, we identified discernable gaps between Delaware and New York law relating to certain recurring issues that come up in transactions.

recent decision from the Delaware Chancery Court highlights another important difference in approach that affects both drafting and due diligence considerations for dealmakers. In this case, the court addressed whether a non-compete in a joint venture agreement that binds a party and its “affiliates” restricts ownership of a competing business by a subsequent acquirer of one of the JV parties. Put simply, is a “future” affiliate captured by this restrictive covenant?

The Delaware court came down decisively on the side of measuring “affiliate” status on a rolling basis at each time that contract compliance was tested as opposed to the moment in time when the contract was signed. It is clear that Delaware courts view covered “affiliates” as a dynamic group, rather than the result of a one-time snapshot. While the specific language of the contract was a factor in the decision, the court also noted the practical absurdity of freezing the covered affiliate group at signing — a party would then be able to form a new subsidiary the day after signing and run competitive business through that newly formed affiliate.

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Delaware Court Rejects Buyer’s Claim of an MAE

Roger Morscheiser, Scott Petepiece, and George Casey are partners at Shearman & Sterling LLP. This post is based on their Shearman 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 Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? by John C. Coates, Darius Palia, and Ge Wu (discussed on the Forum here).

On July 9, 2021, Vice Chancellor Slights of the Delaware Court of Chancery, in Bardy Diagnostics, Inc. v Hill-Rom, Inc. (Del. Ch. July 9, 2021), ordered specific performance to compel Hill-Rom, Inc. (“Hillrom”), a publicly held, global medical technology company, to close the acquisition of Bardy Diagnostics, Inc. (“Bardy”), a medical device startup, upon finding that Hillrom failed to prove that a significant decrease in the Medicare reimbursement rate for Bardy’s sole product offering constituted a Material Adverse Effect (“MAE”), as defined in the merger agreement.

Background

Bardy has a single product offering on the market: an ambulatory electrocardiogram device marketed as the Carnation Ambulatory Monitor (“CAM”) patch. One of Bardy’s largest sources of revenue is through Medicare reimbursements for the CAM patches. The Centers for Medicare & Medicaid Services (“CMS”), an arm of the federal Department of Health and Human Services, develops and administers Medicare’s reimbursement policy. CMS, in turn, authorizes a private entity, Novitas Solutions, Inc. (“Novitas”), to set the reimbursement rates applicable to the CAM patch, which in 2020, was approximately $365 per CAM patch.

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Court of Chancery Decision Provides Guidance for Drafting MAE Clauses

Gail Weinstein is senior counsel, and Philip Richter and Steven Epstein are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Richter, Mr. Epstein, Brian T. Mangino, Randi Lally, and Erica Jaffe, and is part of the Delaware law series; links to other posts in the series are available here.

In Bardy Diagnostics v. Hill-Rom (July 9, 2022), the Delaware Court of Chancery followed its almost invariable pattern of finding that an event arising between signing and closing of a merger agreement did not constitute a Material Adverse Effect that permitted the buyer to terminate the deal.

The decision is noteworthy for the court’s award of the remedy of prejudgment interest, running from the time the merger would have closed. The court also ordered specific performance, but denied the target’s request for other compensatory damages. Most importantly, the decision provides insight into the court’s interpretation of the drafting of a number of MAE provisions (as discussed below).

In this case, the event was an unexpected and dramatic reduction in the Medicare reimbursement rate for the target company’s sole product (a patch used to detect heart arrhythmias and related services). The court, following Delaware’s traditional approach to evaluating whether an MAE occurred, concluded that the effects of the event did not have “durational significance”; and that, in any event, the language of the MAE provision in the merger agreement excluded this event from constituting an MAE. The court therefore ordered the buyer to close.

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