The Delaware Law Series


Recent Delaware Corporate Law Trends and Developments

Edward B. Micheletti and Jenness E. Parker are partners and Lauren N. Rosenello is an associate at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on their Skadden memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

On March 22, 2022, Skadden hosted a webinar on recent developments in Delaware corporate law. Litigation partners Edward Micheletti and Jenness Parker and litigation associate Lauren Rosenello led the discussion, which covered a range of issues that will bear on Delaware companies in 2022, and may affect future litigation, including:

  1. the increasing number of books and records demands under 8 Del. C. §220, and related litigation;
  2. recent merger litigation trends involving Corwin and de facto controllers;
  3. significant developments in derivative litigation;
  4. trends in disputes involving material adverse effects (MAEs) and “ordinary course covenants” in the wake of the COVID-19 pandemic and the Ukraine conflict; and
  5. recent decisions in the emerging area of SPAC litigation.

Below are high-level takeaways.

Books and Records Demands

Demands for books and records pursuant to Section 220 have been on the rise. Traditionally, books and records demands were precursors to derivative litigation, but now stockholders are also using Section 220 to lay the groundwork for class action M&A damages suits. Stockholders will use books and records to bolster post-closing actions against defenses, including that a deal was approved by a fully informed, uncoerced vote of disinterested stockholders.

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Freeze-Out of Minority Not “Entirely Fair”—Salem Cellular

Gail Weinstein is senior counsel, and Andrew Colosimo and Mark H. Lucas are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Colosimo, Mr. Lucas, Bret T. Chrisope, Andrea Gede-Lange, and Shant P. Manoukian, 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 Effect of Delaware Doctrine on Freezeout Structure and Outcomes: Evidence on the Unified Approach by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here); and Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

In In re Cellular Telephone Partnership Litigation (Mar. 9, 2022), a wholly-owned subsidiary of AT&T, Inc., which was the 98.12% controlling partner of Salem Cellular Telephone Company (the “Partnership”), froze out the minority partners by acquiring the Partnership’s assets and liabilities and then liquidating the Partnership. AT&T paid to the Partnership, and then caused the Partnership to distribute to the minority partners their respective pro rata shares of, the Partnership’s value as had been determined by a major national valuation firm that AT&T had retained (the “Valuation Firm”). Litigation ensued with respect to AT&T’s freeze-out of the minority partners of this and fifteen other AT&T cellular partnerships. In the decision issued March 9, 2022, which related only to the plaintiffs’ fiduciary claims against AT&T with respect to the freeze-out of Salem Cellular’s minority partners (the “Freeze-out”), the Delaware Court of Chancery held that the transaction (which, as the parties had agreed, was subject to the “entire fairness” standard of review because the controller stood on both sides of the transaction), did not satisfy the entire fairness standard and that AT&T therefore had breached its duty of loyalty to the minority partners.

Most notably, the decision suggests that outside appraisal, alone, may not be sufficient to establish entire fairness—at least where, as was the case in Salem Cellular, the court views the controller’s timing and initiation of the transaction at issue to have been opportunistic (i.e., designed to benefit the controller at the expense of the minority); the appraisal was by a firm retained by the controller; and the court views the appraisal as seriously flawed.

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Liability When Stockholder’s Merger Consideration is Paid to Hackers

Gail Weinstein is senior counsel and Brian T. Mangino and Maxwell Yim are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Mangino, Mr. Yim, Randi Lally, Amber Banks (Meek), and David L. Shaw, and is part of the Delaware law series; links to other posts in the series are available here.

In Sorenson Impact Foundation v. Continental Stock Transfer & Trust Company (Apr. 1, 2022), computer hackers intercepted the email communications of a law firm (the “Law Firm”) involved with the $130 million merger pursuant to which Tassel Parent, Inc. (the “Buyer,” a subsidiary of private equity firm KKR) was acquiring Graduation Alliance, Inc. (the “Target”). The hackers posed online as two of the Target’s actual stockholders and succeeded in having the merger consideration paid to them instead of the stockholders. The hackers were never apprehended or identified. The actual stockholders—Sorenson Impact Foundation and James Lee Sorenson Family Foundation—brought suit in the Delaware Court of Chancery against Continental Stock Transfer & Trust Company (the “Paying Agent”), the Buyer, and the Target (which was the surviving corporation and which we refer to herein, in combination with the Buyer, as the “Company”). Vice Chancellor Glasscock (i) dismissed the claims against the Paying Agent on the basis of lack of personal jurisdiction; (ii) let stand the claims against the Company; and (iii) left open the issue whether the Law Firm (which had communicated directly with the hackers) was a necessary party to the action and must be joined as a defendant.

Background. The Sorenson entities properly submitted their letters of transmittal and stock certificates to the Paying Agent, requesting payment in their name to an account at Zions Bank in Utah. Computer hackers then intercepted the Sorenson entities’ email communications with the Law Firm. (Which entity was represented by the Law Firm was in dispute.) Assuming the identity of the Sorenson entities, the hackers then communicated via email with the unsuspecting Law Firm and requested that payment of the merger consideration be changed to an international account at a Hong Kong bank. A week later, they requested that the payment be made in the name of HongKong Wemakos Furniture Trading Co. The Law Firm communicated these instructions to the Paying Agent.

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Where Nonprofits Incorporate and Why It Matters

Peter Molk is associate professor of law at the University of Florida Levin College of Law. This post is based on a recent paper by Professor Molk, forthcoming in the Iowa Law Review.

Delaware’s dominance in the race for publicly traded company incorporations is well known. Its success in attracting other types of entities, however, is less understood but no less important. In my paper Where Nonprofits Incorporate and Why It Matters, I study the incorporation behavior of nonprofits, a trillion dollar industry that employs twelve million people and includes some of the most well-known organizations in the world. I find evidence that nonprofits, like publicly traded firms, engage in intentional and strategic incorporation decisions, although at a lower rate. I also find that nonprofits’ incorporation decisions are more consistent with choosing states that maximize nonprofits’ agency costs, rather than minimize them, representing a potential “stroll to the bottom” among nonprofit corporations. The findings raise policy issues about the state of nonprofit law and regulation that I address with attainable, evidence-based solutions.

My paper has three goals. First, I develop the theoretical case for strategic nonprofit incorporations. Just as the state of incorporation can affect publicly traded firms’ cost of capital and therefore their competitive advantage, so too can it affect nonprofits’ operations. Like with traditional corporations, nonprofits’ incorporation state determines the law that governs internal disputes and the courts that often decide those disputes. This can affect nonprofits’ capital costs; although nonprofits lack investors, they often rely as a substitute on capital donations from external donors. If a state’s law and courts offer donors strong protections—such as by imposing efficient fiduciary duties on management, providing donor standing to sue, or requiring company policies on conflicted transactions and whistleblower complaints—then nonprofits that incorporate in that state could achieve lower capital costs through higher donations. The incorporation state also determines which state attorneys general have oversight responsibility for the nonprofit’s operations, which can also impact nonprofit operations. State attorneys general are charged with primary responsibility for policing nonprofits’ operations, so incorporating in a state with strong oversight could enhance donors’, employees’, customers’, and suppliers’ trust in the nonprofit, increasing the firm’s market advantage. As a matter of organizational theory, therefore, nonprofits should prefer to incorporate in some states over others, just as with publicly traded corporations.

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Creditor Deemed a Controller by Dint of Its Voting Power

Lynn K. Neuner and Jonathan K. Youngwood are partners and Janet Gochman is senior counsel at Simpson Thacher & Bartlett LLP. This post is based on their Simpson Thacher memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

On February 28, 2022, the Court of Chancery of Delaware denied dismissal of a breach of fiduciary duty claim in a putative class action brought by a target company’s former stockholders against the target’s largest creditor, which had threatened to block the target’s pending SPAC merger unless the target’s board agreed to a series of amendments to debt and warrant agreements. Blue v. Fireman, 2022 WL 593899 (Del. Ch. 2022) (Zurn, V.C.). The court concluded that plaintiffs sufficiently pled that the creditor was the target’s controller by virtue of its voting power and, therefore, owed the target’s stockholders a duty of loyalty. The court further determined that plaintiffs pled that the creditor breached that duty by refusing to vote its proxy in favor of the merger unless it received the amendments it sought.

Background

In 2020, around the time the target was negotiating the key terms of its pending merger with a SPAC, its largest creditor demanded favorable amendments to debt and warrant agreements. The creditor controlled 83% of the target’s voting power through an irrevocable proxy. After the target board unanimously approved the merger documents, the creditor declared that it would not vote its proxy in favor of the merger unless its demands were met. The target board went on to approve the amendments and announced the merger, which was valued at approximately $120 million. Plaintiffs, former target stockholders, commenced this action alleging breach of fiduciary duty, among other claims, against the creditor and its affiliates as controllers, and certain directors the creditor had appointed to the target’s board. Plaintiffs alleged that as a result of the amendments, $40 million in merger consideration was diverted from the target’s stockholders to the creditor. Defendants moved to dismiss.

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Corwin Cleanse Clarified: Key Lessons for Interested Directors

Robert Velevis is partner and Natalie Piazza is an associate at Sidley Austin LLP. This post is based on their Sidley 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).

Since Corwin v. KKR Financial Holdings LLC, Delaware courts have adhered to the proposition that “when a transaction not subject to the entire fairness standard is approved by a fully informed, uncoerced vote of the disinterested stockholders, the business judgment rule applies.” However, The Delaware Court of Chancery recently issued an opinion (available here) clarifying the application of Corwin to the fiduciary duties of interested directors. The Court declined to dismiss a complaint alleging that the defendant directors’ approval of a merger was a breach of the directors’ duty of loyalty and constituted unjust enrichment. Specifically, the Court rejected the defendant directors’ contention that Corwin “cleansed” the transaction, and, as a consequence, explained that a duty of loyalty analysis was still appropriate. In what follows, we describe this case and offer some important takeaways concerning interested directors.

Key Factual Background

In May 2020, the board of directors of WinView, Inc. closed a merger whereby WinView merged with a wholly owned subsidiary of a Canadian company to create a new entity, Engine Media Holdings, Inc. Following the consummation of the merger, several stockholders sued, claiming that the named directors breached their fiduciary duties to the company and its shareholders and were unjustly enriched as a result.

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Chancery Court Rules Target’s Pandemic Responses Did Not Breach Ordinary Course Covenant

Gail Weinstein is senior counsel, and Steven Epstein and Philip Richter are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Epstein, Mr. Richter, Warren S. de Wied, Erica Jaffe, and Randi Lally, 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 Stakeholder Capitalism in the Time of COVID, by Lucian Bebchuk, Kobi Kastiel, and Roberto Tallarita (discussed on the Forum here); 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); The New Look of Deal Protection by Fernan Restrepo and Guhan Subramanian (discussed on the Forum here); and Deals in the Time of Pandemic, by Guhan Subramanian and Caley Petrucci (discussed on the Forum here).

In Level 4 Yoga, LLC v. CorePower Yoga, LLC (Mar. 1, 2022), the Delaware Court of Chancery ordered CorePower Yoga, LLC to close the agreement it had entered into, pre-pandemic, to acquire the yoga studios owned by its franchisee, Level 4 Yoga, LLC. CorePower had contended, in March 2020, just before the first of three scheduled closings of the asset purchases, that it was no longer obligated to close the almost $30 million transaction due to the pandemic having emerged in the U.S. and businesses across the country, including Level 4’s studios, having shut down. In this post-trial decision, the court ruled that the pandemic did not constitute a “Material Adverse Effect” and that the closure of the studios did not violate Level 4’s covenant to operate, pending closing, in the ordinary course of business. The court ordered CorePower to close and to pay compensatory damages for the delay in closing.

Key Points

  • The decision was based on atypical features of the transaction and the parties’ relationship. Due to the unusual background of the transaction, the parties had structured their asset purchase agreement without conditions or termination rights—suggesting that they had intended that the closing would occur even if a party breached the agreement. In addition, due to the parties’ relationship as franchisor and franchisee, CorePower (as the franchisor) had directed Level 4’s operational responses to the pandemic. Given the unique factual context, in our view the decision offers little predictive value as to future rulings on a buyer’s failure to close based on an extraordinary event occurring between signing and closing.
  • The court followed the same analytical framework for determining whether the target breached the ordinary course covenant as it applied in the prior two cases—AB Stable and Snow Phipps—in which it has addressed whether the pandemic excused a buyer from closing. In all three cases, the court has interpreted “ordinary course of business” to mean the ordinary course during “normal times” (rather than ordinary course in light of an extraordinary event having occurred); and has interpreted “consistent with past practice” to mean that the only relevant issue is whether the target’s own post-signing operations changed materially from its pre-signing (pre-pandemic) operations. In AB Stable, the court found that the target’s responses to the pandemic constituted a breach of the covenant and that the buyer therefore was not obligated to close; in both Snow Phipps and Level 4 Yoga, the court found that the target’s pandemic responses did not constitute a breach of the covenant and the court ordered the buyer to close.  These cases underscore the facts-intensive nature of the court’s determination as to breach of an ordinary course covenant.
  • The decision continues the Delaware courts’ almost invariable trend in finding that an extraordinary event occurring between signing and closing was not an MAE that excused a buyer from closing. There has only been one Delaware decision ever—Akorn (issued in 2018)—finding that a “Material Adverse Effect” (or “Material Adverse Change”) occurred that excused a buyer from closing. In all three pandemic-related cases, the court has found that the pandemic was not an MAE—based on the parties’ “MAE” definition, the extent of the pandemic’s impact, and/or the lack of “durational significance” of the impact. In Level 4 Yoga, the court found that, at the time CorePower asserted that it had a right not to close, it had no basis to believe that the effects of the pandemic would have durational significance as the closure of the studios was at that time expected to last only a few weeks.
  • The court emphasized that it “will not hesitate” to order specific performance by a buyer who improperly refuses to close.

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Recent Delaware Court of Chancery SPAC Opinions

Nathan E. Barnett and Benjamin Strauss are partners at McDermott Will & Emery LLP. This post is based on their MWE 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 SPAC Law and Myths by John C. Coates (discussed on the Forum here).

Highlighted below are several recent opinions from the Delaware Court of Chancery relating to special purpose acquisition companies (SPACs) that provide helpful guidance to sponsors, investors and practitioners. These cases are a good reminder that well-worn principles of Delaware law still apply in the SPAC context:

  • In In re Multiplan Corp. Stockholder Litigation, 2022 WL 24060 (Del. Ch. Jan. 3, 2022), the court, on a motion to dismiss (meaning that inferences are drawn in favor of the plaintiff and claim dismissal is inappropriate unless the plaintiff would not be entitled to recover under any reasonably conceivable set of circumstances), (i) held the entire fairness standard of review (the most onerous standard under Delaware law) applied to a de-SPAC transaction where SPAC fiduciaries (including the sponsor) allegedly suffered from inherent conflicts with public stockholders due to the economic benefit they received in the transaction and (ii) denied dismissal of stockholders’ fiduciary duty claims against those fiduciaries for allegedly making materially misleading disclosures that impaired the stockholders’ ability to make a fully informed decision whether to redeem their stock in connection with the transaction.
  • In Brown v. Matterport, Inc., 2022 WL 89568 (Del. Ch. Jan. 10, 2022), the court held that the plain terms of a lock-up provision in a SPAC’s bylaws rendered the lock-up inapplicable to certain of the post-closing stockholders since those stockholders did not receive their post-closing shares “immediately following” the merger transaction, as was required under the lock-up provision. Delaware courts will apply the literal text of a contract (e.g., bylaws) as opposed to what may have been the spirit of the agreement.
  • In In re Forum Mobile, Inc., 2022 WL 322013 (Del. Ch. Feb. 3, 2022), the court denied appointment of a custodian over a defunct Delaware corporation (whose shares retained a CUSIP number) where the petitioner intended to revive the corporation in order to access the public markets. Delaware has a long-standing policy against permitting entrepreneurs to manipulate Delaware law for the purposes of reviving defunct Delaware entities with still-extant listings and using them as vehicles to access the public markets.

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Implications of Lee for a Board’s Decision to Reject a Nomination Notice

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

In Strategic Investment Opportunities v. Lee Enterprises (Feb. 14, 2022), the Delaware Court of Chancery reviewed the decision by the board of directors of Lee Enterprises, Inc. (“Lee”) to reject the director nominations notice provided by its dissident stockholder Strategic Investment Opportunities LLC (“Opportunities”). Opportunities is an affiliate of hedge fund Alden Global Capital LLC, which is in the midst of a hostile takeover bid for Lee. The court found, first, that the nomination notice plainly did not comply with the technical requirements of Lee’s advance notice bylaw. The court then applied an enhanced scrutiny standard of review to determine whether Lee’s directors had breached their fiduciary duties by not waiving, or allowing Opportunities to cure, any technical defects in the nomination notice. The court found that the directors’ actions had been “reasonable and appropriate” under the circumstances and upheld their rejection of the nominations.

Key Point

The decision emphasizes that, generally, a stockholder must comply precisely with the technical requirements of advance notice bylaws—but also reaffirms that a board must act in good faith and equitably in rejecting even a plainly non-compliant nomination notice. Reaffirming long-standing principles relating to the validity of advance notice bylaws, the court stressed that Lee’s advance notice bylaw was adopted on a “clear day,” far in advance of Alden’s takeover bid and the nomination notice; that the bylaw requirements were unambiguous and reasonable; and that Lee had not interfered with Opportunities’ ability to comply. The court endorsed a corporation’s “genuine interest in enforcing its Bylaws so that they retain meaning and clear standards that stockholders must meet” and readily found that Opportunities’ notice did not comply with “the letter” of Lee’s bylaw. The decision serves as a reminder, however, that a board must act in good faith and equitably when deciding to reject a nomination notice, even when the notice is non-compliant with the bylaw, is submitted outside a takeover context, and/or involves nominations for a minority of the board seats.

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Bargaining Inequality: Employee Golden Handcuffs and Asymmetric Information

Anat Alon-Beck is Assistant Professor at Case Western Reserve University School of Law. This post is based on her recent paper, and is part of the Delaware law series; links to other posts in the series are available here.

Unicorn valuations are notoriously inaccurate and well-documented in the finance literature. Silicon Valley’s dirty little secret is that a company can achieve a unicorn valuation by providing extensive downside protections to late-stage investors. Employees of these large, privately held companies do not have access to fair market valuation or financial statements and, in many cases, are denied access to such reports, even when requested.

Unicorn employees are granted equity as a substantial part of their compensation, however due to the inferior position of employees in comparison to the start-up founders and other investors, information shedding light on the value of their equity grants is often withheld.

Start-up founders, investors, and their lawyers sometimes systematically abuse equity award information asymmetry to their benefit. My paper, Bargaining Inequality: Employee Golden Handcuffs and Asymmetric Information, forthcoming in Maryland Law Review sheds light on the latest practice that compels employees, who are not yet stockholders, to waive their stockholder inspection rights under Delaware General Corporation Law (“DGCL”) Section 220 as a condition to receiving stock options from the company.

Perhaps the clearest indication of this new practice is the recent amendment to the National Venture Capital Association legal forms, which is intended to standardize a contractual “waiver of statutory inspection rights.” This waiver is designed to contract around stockholder inspection rights and prevent employees from accessing information about the value of their stock.

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