The Delaware Law Series


Federal Forum Selection Bylaws for Securities Act Claims

Andrew Clubok, Blair Connelly, and Matt Rawlinson are partners at Latham & Watkins LLP. This post is based on a Latham memorandum by Mr. Clubok, Mr. Connelly, Mr. Rawlinson, Michele Johnson, Gavin Masuda, and Colleen Smith. 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 The Market for Corporate Law by Michal Barzuza, Lucian A. Bebchuk, and Oren Bar-Gill; Federal Corporate Law: Lessons from History by Lucian Bebchuk and Assaf Hamdani; and Delaware Law as Lingua Franca: Evidence from VC-Backed Startups by Jesse Fried, Brian J. Broughman, and Darian M. Ibrahim (discussed on the Forum here).

The decision is a positive development for Delaware corporations seeking to reduce duplicative state court litigation arising from public securities offerings.

On March 18, 2020, the Delaware Supreme Court issued its long-awaited decision in Salzberg v. Sciabacucchi, holding that federal forum selection bylaws and charter provisions for claims arising under the Securities Act of 1933 are facially valid under Delaware law. Such forum selection provisions were broadly implemented in the wake of the United States Supreme Court’s decision in Cyan, Inc. v. Beaver County Employees’ Retirement Fund, in which the Court held that claims arising under the federal Securities Act of 1933 could be filed either in state or federal court. Through bylaw and charter provisions, many companies sought to avoid the implications of Cyan by requiring Securities Act claims be brought exclusively in federal (not state) courts.

While the Delaware Court of Chancery had rejected the validity of federal forum selection bylaws, the Delaware Supreme Court has now concluded otherwise. This decision is a significant and positive development for Delaware corporations seeking to stem the tide of duplicative state court litigation arising from public securities offerings.

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Rights Plans (“Poison Pills”) in the COVID-19 Environment—“On the Shelf and Ready to Go”?

David A. Katz and Sabastian V. Niles are partner at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum. Related research from the Program on Corporate Governance includes Toward a Constitutional Review of the Poison Pill by Lucian Bebchuk and Robert J. Jackson, Jr. (discussed on the Forum here); and The Case Against Board Veto in Corporate Takeovers by Lucian Bebchuk.

The human and business challenges confronting America from the COVID-19 pandemic are unprecedented. These global challenges have also emerged during a time when most companies have unfortunately given up nearly all of the traditional and effective “takeover” defenses like classified boards, have structural profiles that do not deter (and may invite) opportunistic attack and whose non-index fund investors continue to confront tremendous pressure to show short-term performance or face redemption requests. As a number of public companies have seen the value of their common stock decline precipitously, some advisors have suggested to public company directors that such companies should rush to adopt and announce shareholder rights plans, known more colloquially as “poison pills,” solely in response to significant stock price declines. A handful of companies, especially those whose market capitalization have dropped below $1 billion, have implemented pills in recent weeks due to the now-present possibility of building a large stake rapidly and under the disclosure radar. In addition, a number of other companies facing specific threats of disruption, takeover threats, activist attacks, unusual trading activity or the need to preserve value and an announced strategic direction have considered implementing (and in some cases implemented) rights plans.

Our Firm developed the shareholder rights plan in 1982 and after almost four decades, this creation has withstood the test of time. We litigated the legality of the poison pill in the Delaware Supreme Court in 1985 in the Moran v. Household Int’l case, where the court found that the plan’s implementation was a legitimate exercise of business judgment by Household’s board. And over the last four decades, we have regularly modified and adapted the rights plan to meet evolving and current business and market conditions.  Since the Moran case, our Firm has regularly defended the use of rights plans in Delaware and other jurisdictions and established its legality, culminating in the Delaware Airgas decision in 2011. Airgas reaffirmed the primacy of the board of directors in matters of corporate control under bedrock Delaware law and upheld the use of a rights plan to defeat a year-long, opportunistic hostile takeover attempt. We have litigated other favorable court rulings upholding rights plans and other defensive measures in a variety of contexts, including aggressive activism.  Our Firm has adapted our form of rights plan for the COVID-19 crisis. We will use our expertise in designing and using the rights plan to sustain its legality and effectiveness in the current crisis environment and continue to provide judgment as to when and whether to adopt a pill.

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The “Market Exception” in Appraisal Statutes

GIl Matthews is Chairman and Senior Managing Director of Sutter Securities, Inc. This post is based on his Sutter Securities 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 Using the Deal Price for Determining “Fair Value” in Appraisal Proceedings (discussed on the Forum here) and Appraisal After Dell, both by Guhan Subramanian.

Introduction: Public Shareholders and Appraisal Rights

Appraisal is a right and a remedy. Available by statute in all states, appraisal provides dissenting shareholders the right to require the corporation to pay them the ‘fair value’ of their shares upon some mergers or other fundamental changes. Appraisal statutes provide procedures for dissenting shareholders to receive a judicial hearing in which the court appraises the value of their interests. A primary purpose of appraisal statues is to protect minority shareholders. The intent of appraisal valuations by courts is to compensate dissenting minority shareholders equitably for the unwanted change in their investments. Therefore, in appraisals, courts in most states employ a valuation standard called “fair value,” which is considered to be a fuller measure of value that can result in an assessment higher than market price.

Appraisal rights and fair value assessments are broadly available for shareholders of private companies. However, 38 states now restrict the appraisal rights of shareholders of public companies through a provision in their appraisal statutes called a “market exception” (also called a “market-out” or a “market-out exception”). With varying specifics, these statutes deny shareholders of publicly traded companies the right to the court-awarded assessment to which similarly-situated private company shareholders are entitled.

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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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