Clients can pick their own attorneys but they cannot pick their own facts. A recent case decided by Master Ayvazian highlights the difficulties that unfortunate facts can present.

Creditors have eight months to file a claim against an estate (see 12 Del.C. §2102(a)). After a claim is presented, the executor (or personal administrator) can pay the claim or can deny the claim. Other than failure to timely file the claim (see 12 Del.C. §2102(a)), there is no statutory justification for denial of claim. In fact, Delaware has historically held that fiduciaries owe a fiduciary duty to creditors. See In re Estate of Bennie P. Farren, Del. Ch., C.A. No. 9385-MA (June 18, 2015).

Last will and testament
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Delaware Acceptance Corporation, CACV of Colorado, LLC and 202 Investments, Inc. v. Estate of Frank C. Metzner, Sr., Lona C. Metzner, Executrix and Frank C. Metzner, Jr., the Metzner Family, LLC, C.A. No. 8861-MA involved an executor who denied a claim in the amount of $41,002.59 which had been filed against the estate by a credit card company. After four years of litigation, the Court of Chancery, Master Kim Ayvazian, found that the case hinged on the authenticity of a document, which in turn depended upon the credibility of several witnesses. The Court found that the backdating of documents and the offering of false testimony at trial rendered the Executrix unfit to serve as fiduciary and ordered her removal.

Frank C. Metzner, Sr. (“Frank , Sr.”) and his wife, Lona C. Metzner (“Lona”), deeded their house in Lewes into the Metzner Family Limited Liability Company (the “LLC”) in 2002. Frank, Sr. and Lona each held originally a fifty percent interest in the LLC but subsequently they gave two percent to their son, Frank, Jr.

In 2003, Frank, Sr. and Lona stopped paying their bills, including their credit cards, when the outstanding balance totaled approximately $55,000. Plaintiffs Delaware Acceptance Corporation CACV of Colorado, LLC and 202 Investments, Inc. (“Creditor”) sought a Charging Order based upon the Court of Common Pleas judgments that had been entered against Frank, Sr. and Lona. The Charging Order was signed on December 6, 2010 and served upon the LLC to attach to any distributions from the LLC to either Frank, Sr. or Lona. Frank, Sr. and Lona’s personal residence which was the asset of the LLC clearly did not have any income spitting out so the Charging Order laid dormant.

Subsequently Frank, Sr. died on October 26, 2012 and his Will, which was filed on December 5, 2012, named Nona as executor. The sole asset in the Estate was Frank, Sr.’s 49% interest in the LLC which was left to his son, Frank, Jr. Creditor filed its claim against the Estate on April 15, 2013. The Estate’s attorney denied the claim by letter dated June 3, 2013 on the basis that: (1) the Estate was devoid of assets other than the 49% LLC interest; (2) it was understood that the Charging Order was not dissolved by Frank, Sr.’s death; (3) Frank, Sr.’s 49% interest transferred under the Will to Frank, Jr. remained subject to the Charging Order. This was unacceptable to the Creditor.

Under the LLC Agreement (as was common in those days), the death of a member was considered a withdrawal, resulting in the dissolution of the LLC unless the surviving members elected to continue the LLC within 90 days of the death of the member. If the LLC were dissolved, 49% of the personal residence would have been distributed out to the Estate of Frank, Sr. thereby, the Executrix (faced with the Charging Order) as a fiduciary for the creditor, could have been directed to sell the house to satisfy the claim.

Within the required three month window (under 12 Del.C. 2102(b)) the Creditor filed a complaint alleging its belief that the LLC had dissolved after the death of Frank, Sr. due to the failure of the remaining members, Lona and Frank, Jr., to have consented in writing to continue the LLC within the 90 days after Frank, Sr.’s death.

In response, the Executor alleged that the remaining members (Lona and Frank, Jr.) had effectively elected to continue the LLC after Frank, Sr.’s death and proffered first a signed writing dated November 30, 2012 (the “Election”).

The Court found the Election suspect and in an effort to discern the actual date of the Election, directed the Creditor’s attorney to request the metadata relevant to the Election from the computer of the attorney who had drafted the document and/or such attorney’s former firm’s network server and to produce the data to the Court within 60 days. If the metadata was not produced, the Court would draw an adverse inference that the Election had been created after the 90-day period following Frank, Sr’s death. No metadata was ever delivered to the Court.

The attorney testified that he believed that the Election had been prepared in his office although the Election did not have certain identifiable marks (e.g. file number) that would evidence such preparation, nor was the Election-signing ceremony on the attorney’s calendar.

Undeterred, at trial Lona introduced a second document that had not previously been produced during the litigation (the “November 10th letter”). The November 10th letter (admittedly written by Lona) would have served as a sufficient writing to continue the LLC had the Court believed its provenance or if the metadata associated with the November 10th letter been provided. According to Lona’s testimony at trial, however, the computer that had generated the November 10th letter had “gone bad” a few years ago and had been disposed of.

Unfortunately for her, Lona was not a credible witness.

In concluding that Lona should be removed as Executor for cause, the Court held that a person who backdates documents and offers false testimony at trial should not be a fiduciary of an estate. The Court ordered the appointment of a new personal administrator with an order to: (1) dissolve the LLC; (2) liquidate the assets in the LLC; and (3) make disbursements to pay off the Creditor as required in the Changing Order.

Key takeaways:

First, review LLC Agreements to discern whether mandatory election is necessary and advisable and amend the LLC Agreement if appropriate. Second, only go into trial with a firm belief in the honesty of your client’s version of the facts. Otherwise, don’t let your client pick you as their attorney.

In Delaware, to assert a derivative action against company management, either a presuit demand must be made, or plaintiff must allege that demand would be futile because the board is not disinterested.   For derivative actions asserted by shareholder against a corporation or of an unincorporated association, Court of Chancery Rule 23.1 requires that the complaint “allege with particularity the efforts, if any, made by the plaintiff to obtain the action the plaintiff desires from the directors or comparable authority and the reasons for the plaintiff’s failure to obtain the action or for not making the effort.”  Ct. Ch. R. 23.1.

The Delaware Limited Liability Act similarly requires that a complaint must “set forth with particularity the effort, if any, of the plaintiff to secure initiation of the action by a manager or member or the reasons for not making the effort.”  6 Del. C. § 18-1003.  Thus, members of a Delaware LLC must likewise allege presuit demand, or demand futility.

An interesting question becomes whether this requirement applies to 50/50 “joint venture” limited liability companies, in which two 50/50 managing members have equal control over the company.  The recent decision of Diestrichson v. Knott, et al., C.A. No. 11965-VCMR (Del. Ch. Apr. 19, 2017) answers in the affirmative.  There, a managing member who held a 50% interest in the entity asserted claims against the other 50% owner for breach of fiduciary duty by paying himself an unauthorized salary and misappropriating the proceeds of an asset sale.  Plaintiff also brought claims for breach of the operating agreement and the implied covenant of good faith and fair dealing.

Vice Chancellor Montgomery-Reeves rejected plaintiff’s reliance upon El Paso Pipeline GP Co., L.L.C. v. Brinckerhoff,  152 A.3d 1248 (Del. 2016), in support of the proposition that the fiduciary duty claims were “dual-natured”, i.e., possessing both derivative and direct qualities.  The Court noted that in Brinckerhoff, the Delaware High Court stated that in “unique circumstances” it has recognized that certain claims have both direct and derivative aspects.  This namely occurs when the action involves a controlling stockholder and transactions “that resulted in an improper transfer of both economic value and voting power from the minority stockholders to the controlling stockholder.”  Brinckerhoff, 152 A.3d at 1262.

Because plaintiff did not allege any dilution of voting power in the case, the Court found that Brinckerhoff did not apply. And because plaintiff did not alleged demand futility or that demand was made and wrongfully refused, the derivative claims were dismissed.

Key Takeaway: In actions between two managing members of a 50/50 limited liability company, a common assumption is that any traditionally derivative claims, such as breach of fiduciary duty, would be direct given the bilateral composition of the LLC.  Such an assumption could be problematic and may lead to dismissal of such claims, if plaintiff fails to allege facts that a direct harm was likewise incurred, such as dilution of voting power.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

As discussed in various prior posts, a petitioner making a Section 220 books and records demand must state a “proper purpose” to justify inspection. Commonly approved purposes include valuation of stock, and investigation of wrongdoing.

The recent decision of Rodgers v. Cypress Semiconductor Corp., C.A. No. 2017-0070-AGB (Del. Ch. Apr. 17, 2017) sheds light on the standard needed to obtain inspection of books and records to investigate corporate wrongdoing.  There, a former chief executive officer sought inspection to investigate alleged excessive compensation paid to the chairman of the board.  Petitioner also alleged that the chairman violated the company’s code of ethics.

The Court reiterated the point that petitioner need not prove that wrongdoing is actually occurring.  Rather, petitioner need only show, by a preponderance of the evidence, a credible basis from which the Court of Chancery can infer there is possible mismanagement that would warrant further investigation.  Chancellor Bouchard stated that such credible basis may be established through “documents, logic, and testimony”.

The Court also rejected the corporation’s assertion that the stated purpose was not the actual intent behind the demand.    The Court reiterated that it is very difficult to prove that a stockholder’s stated purpose is actually not the true purpose for seeking inspection.  Quoting Pershing Square, L.P. v. Ceridian Corp., “Such a showing is fact intensive and difficult to establish.” 923 A.2d 810, 817 (Del. Ch. 2007).  In light of this high hurdle, Chancellor Bouchard granted petitioner CEO’s inspection demand.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

The recent decision of Trusa v. Nepo, C.A. No. 12071-VCMR (Del. Ch. April 13, 2017), stands for the proposition that a creditor lacks standing to assert a derivative claim against a limited liability company.  In Trusa, the plaintiff creditor Steven B. Trusa brought a derivative action for breach of fiduciary duty and dissolution of Xion Management, LLC (“Xion” or “LLC”).  The creditor brought such claims, among other reasons, as a result of his assertion that he lent money to the LLC under false pretenses.  One of the managing members moves to dismiss the action for lack of standing, duplication, and failure to state a claim.

Vice Chancellor Montgomery-Reeves granted the motion to dismiss in its entirety.  The Court held that under the plain language of the Delaware Limited Liability Act, only members and assignees can assert derivative claims on behalf of a limited liability company.  The Court rejected Trusa’s argument that the power of attorney provision in the loan agreement granted creditor a contractual right to assert derivative claims, as the clause only permitted Trusa to pursue remedies as provided in the Agreement.

The Court also rejected Trusa’s demands for dissolution and fraud.  Only a member or manager may seek dissolution of a limited liability company under the Delaware LLC Act’s dissolution statute, 6 Del. C. § 18-802.  Moreover, the Court found that the extreme remedy of “equitable dissolution” did not apply.  Finally, the Court rejected the creditor’s attempts to raise fraud in a breach of contract claim.

Notably, the Court rejected Trusa’s argument that because the LLC’s Certification of Formation was automatically cancelled under Section 18-203 of the LLC Act, he should be permitted to seek appointment of a receiver under Section 18-805 of the LLC Act.  But as Vice Chancellor Montgomery-Reeves held:  “a creditor may only seek the appointment of a trustee or receiver [under Section 18-805] when a certificate of cancellation is filed after the dissolution and winding up of the company, not where the certificate of formation has been canceled by operation of law for want of a registered agent.” (emphasis in original).  The Court declined Trusa’s invitation to “read any cancellation method under Section 18-203(a) as triggering the rights granted to creditors in Section 18-805….”

Key Takeaway: Creditors will be denied standing to assert derivative claims to recover damages.  The preferred course is to prepare for such contingencies in the loan documents.  In addition, a creditor must wait until a certificate of cancellation is filed in order to seek appointment of a receiver under Section 18-805 of the LLC Act.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

Whether a claim against company management is direct or derivative is not infrequently disputed in litigation before the Delaware Court of Chancery.  This determination becomes important in many contexts, including whether it was necessary for plaintiff to make a pre-suit demand upon the board, whether derivative claims of a company have been assigned to a receiver, or whether such claims have previously been settled in a prior litigation.

In the recent decision of Sehoy Energy LP, et al. v. Haven Real Estate Group, LLC, et al., C.A. No. 12387-VCG (Del. Ch. Apr. 17, 2017), the Court of Chancery examined the nature of the asserted claims due to the filing of bankruptcy of the entity for whom company management served.  There, investors in a partnership commenced suit against a general partner and its principal, asserting that they breached the partnership agreement, induced plaintiffs to invest capital into the partnership, and breached their fiduciary duties by making decisions based upon self-interest.

After suit was commenced, the partnership, a non-party to the case, filed for bankruptcy.  Plaintiff investors then filed a motion seeking a determination that their claims against the general partner and its principal should not be stayed by the bankruptcy.  Defendants argued that the automatic stay applied to the action.

In considering the investors’ motion, Vice Chancellor Glasscock noted that if the action filed against the general partner was derivative in nature, then it would be stayed under the Bankruptcy Code because it would be an asset of the debtor’s estate.  On the other hand, if the claims are direct, then they are not property of the partnership’s estate, and the Chancery litigation can move forward.

The Court found that certain of the investors’ claims were largely direct, and granted their motion.  Relying upon the well-known Delaware Supreme Court decision of Tooley v. Donaldson, Lufkin & Jenrette, Inc. to determine whether the claims were derivative or direct, the Court examined “(1) who suffered the alleged harm (the corporation or the suing stockholders, individually); and (2) who would receive the benefit of any recovery or other remedy (the corporation or the stockholders, individually)?” 845 A.2d 1031, 1033 (Del. 2004).  The Court found that the investors’ contract claims, breach of fiduciary duty claims, and fraud claims were all direct.  Plaintiffs were willing to agree to forebear certain other claims while the automatic stay remains in effect.

The Court also declined to stay the action in the interest of judicial economy.  Defendants asserted that wasteful overlap would occur between the action and the bankruptcy proceeding.  However, because the parties indicated that no derivative claims would be brought before the bankruptcy court, there would be no likelihood of two separate courts entertaining two lawsuits based upon the same underlying dispute.  Moreover, the Court noted that the elements and remedies surrounding the fraud and nondisclosure claims would be different than corporate mismanagement claims.  Thus, Vice Chancellor Glasscock declined to stay the action in the interest of judicial economy.

Key takeaway: This is an important read for any party involved in litigation, in which a related non-party files for bankruptcy.  In such a situation, Sehoy Energy provides a helpful roadmap in determining whether the pending Chancery action should be stayed or can proceed.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

The Delaware Supreme Court has just handed down a decision that dramatically illustrates the need to take a holistic approach to an estate plan to ensure that what you want to happen to your assets when you die, can and actually will happen.

Courthouse
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Everett T. Conaway died on May 11, 2010, leaving to survive him his second wife, Janice, and his son from his first marriage, Jesse.  Everett named Janice and Jesse as co-fiduciaries of his Will and his Trust.  That was not successful and eventually the Court appointed a local attorney to independently handle the administration (who promptly thereafter sued both Janice and Jesse (see Conaway I, Conaway II and Conaway III).  Carefully consider your appointment of fiduciaries to ensure that the fiduciaries (whether as successor trustees or as executors) can and will work together to complete the administration.  If you have any concerns or hesitation, trust your gut and designate someone else.

Everett had utilized several estate planning tools: a pour-over Will; a Revocable Trust; and a limited partnership.  However, these separate tools were not viewed holistically and therefore Everett’s estate plan was unsuccessful.

For instance, Everett’s Trust held a 69% interest in a limited partnership that he had entered into with Jesse.  Everett attempted to leave that 69% limited partnership interest to Janice.  That was not successful (as discussed in a previous post by my colleague Carl Neff).  There possibly could have been a way to accomplish Everett’s goal to leave this asset to Janice but simply ignoring the limitations that Everett had placed on the limited partnership agreement did not work.

Everett owned in his own name, Conaway Development Industries, Inc., which Everett had sold prior to his death.  Under Everett’s Trust Agreement, Everett left that stock or the sales proceeds from the sale of the stock, to Janice.  Unfortunately, this was not successful either.  Because the stock was in Everett’s name alone (and not held in his Trust), the stock was available to Everett’s creditors (including an approximately $260,000 outstanding balance on an unsecured line of credit).  Everett’s attempt to leave the proceeds from the sale to Janice failed since creditors have the superior right to be paid before beneficiaries.  Had Everett retitled the Conaway Development Industries, Inc. stock (or the proceeds from the sale of the stock) into his Trust (with a simple assignment assuming it was permitted under the limited partnership agreement) Janice could have inherited the same.

Key Takeaway: Review your entire holdings (including how they are titled and whether there are any restrictions) and annually read your estate planning documents to ensure that what you want to happen to your assets, actually can and will happen.

When applicable, former D&Os of Delaware corporations will rely upon a release from the company to shield liability against class action or derivative lawsuits filed thereafter. The recent decision of Seiden v. Kaneko, C.A. No. 9861-VCS (Del. Ch. Mar. 23, 2017) is an interesting read on the effectiveness of such a release.

The action was pursued by a receiver appointed to a Delaware holding corporation, Southern China Livestock, Inc. (“SCLI” or “the Company”), which owned a non-public, China-based operating company.  After accepting capital infused from U.S. based investors, the Company “went dark”, leaving the investors to find ways to recover their investment.  The Company’s former president, Shu Kaneko, was located in the United States, and a receiver was appointed to recover amounts that Kaneko had allegedly diverted from the company accounts.

After Kaneko resigned from the Company but prior to the initiation of this litigation, the Company gave him a general release of claims (the “Release”) in exchange for his commitment to assist the Company in taking certain steps to firm up its capital structure in anticipation of a potential sale of the Company to a private equity firm. Kaneko moved for summary judgment on the ground that the receiver’s claims are barred by the Release.

The receiver argued that the release fails for lack of consideration, for three reasons: (a) the Release should be disregarded because Kaneko’s control over SCLI prevented SCLI from entering into an arm-length agreement with him; (b) the Release was not supported by valid consideration; and (c) the individual who controlled the Company lacked authority to enter into the Release on behalf of the Company.

The Court disagreed with each of these reasons. The Court found that no evidence existed that Kaneko controlled SCLI at the time of the Release.  The Court also found that the Release was legally valid. Finally, the Court rejected the assertion that the individual who controlled the Company lacked authority to enter into the Release.   Accordingly, the Court found that the Release is binding and enforceable and that it releases Kaneko from all claims asserted against him in this litigation.

Key Takeaway

This decision demonstrates the risks that investors take when they invest money into a foreign country in which collecting upon a judgment is difficult. Here, the investors likely spent significant sums of money first to obtain the appointment of a receiver, and then to fund the present litigation.  As a result of the Release, the plaintiffs may be left with little or no recourse in practice. Thus, investors must take appropriate safeguards to protect their investment.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

In the recent decision of In re Oxbow Carbon LLC Unitholder Litig., Consol. C.A. No 12447-VCL (Del. Ch. March 13, 2017), Vice Chancellor Laster provides a comprehensive review of pretrial discovery rules before the Delaware Court of Chancery.  This opinion is an excellent roadmap for conducting discovery in Delaware, and contains a treasure-trove of citations, authorities and maxims that would aid any Chancery practitioner.

Several quotes of import from this decision are as follows:

  • “The scope of discovery pursuant to Court of Chancery Rule 26(b) is broad and farreaching . . . .”
  • Relevance “must be viewed liberally,” and discovery into relevant matters should be permitted if there is “any possibility that the discovery will lead to relevant evidence.”
  • When a party objects to providing discovery, “[t]he burden is on the objecting party to show why and in what way the information requested is privileged or otherwise improperly requested.”
  • Generic and formulaic objections “are insufficient.”
  • In short, “[o]bjections should be plain enough and specific enough so that the Court can understand in what way the discovery is] claimed to be objectionable.”
  • Objection to requests as “excessive, overbroad, and unduly burdensome” is insufficient. “The objecting party must show specifically how each discovery request is burdensome or oppressive by submitting affidavits or offering evidence revealing the nature of the burden.”

Consistent with the recent amendments to the Federal Rules of Civil Procedure governing discovery, this decision reinforces the notion that vague, generic and boiler-plate objections to discovery requests will simply not be tolerated by the Court of Chancery.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

Under Section 220 of the Delaware General Corporation Law (“DGCL”), only stockholders or directors have standing to make a demand to inspect a Delaware corporation’s books and records.  What happens if, after a books and records demand is made upon the corporation, but before an action is commenced before the Court of Chancery, the stock of the demanding stockholder is extinguished through a merger?  This precise issue was addressed in the recent decision of Weingarten v. Monster Worldwide, Inc., C.A. No. 1293-VCG (Del. Ch. Feb. 27, 2017).

In Weingarten, the plaintiff stockholder’s demand was made before a merger closed, but the petition was not filed until after the merger closed.  The merger extinguished the stockholder status of the plaintiff.

In a matter of first impression, Vice Chancellor Glasscock ruled that the “unambiguous language of Section 220(c) compels a finding that a former stockholder squeezed out in a merger thereafter lacks standing to bring an action under [Section 220]”.  The Court made clear that a plaintiff must be a stockholder at the time the petition is filed with the Court of Chancery, distinguishing decisions in which a stockholder lost standing after filing a complaint, through a merger.

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.

In selecting lead counsel for a stockholder derivative litigation, the Court of Chancery applies the factors set forth under Hirt v. U.S. Timberland Service Co., 2002 WL 1558342 (Del. Ch. July 3, 2002).  These factors are as follows:

  • the “quality of the pleading that appears best able to represent the interests of the shareholder class and derivative plaintiffs;”
  • the relative economic stakes of the competing litigants in the outcome of the lawsuit (to be accorded “great weight”);
  • the willingness and ability of all the contestants to litigate vigorously on behalf of an entire class of shareholders;
  • the absence of any conflict between larger, often institutional, stockholders and smaller stockholders;
  • the enthusiasm or vigor with which the various contestants have prosecuted the lawsuit; and
  • [the] competence of counsel and their access to the resources necessary to prosecute the claims at issue.

In making the selection, it is noteworthy that the Court of Chancery recently took into account which counsel initiated a books and records demand to support the allegations of its complaint, rather than relying upon publicly known information. This was an important factor in the decision of In re CytRx Corp. S’holder Deriv. Lit. II, C.A. No. 11800-VCMR (Feb. 22, 2017).

Carl D. Neff is a partner with the law firm of Fox Rothschild LLP.  Carl is admitted in the State of Delaware and regularly practices before the Delaware Court of Chancery, with an emphasis on shareholder disputes. You can reach Carl at (302) 622-4272 or at cneff@foxrothschild.com.