In the letter opinion of Windsor I, LLC v. CWCapital Asset Management LLC, C.A. No. 12977-CB (Del. Ch. July 31, 2017), the Court of Chancery determined the enforceability of an agreement to negotiate, under Maryland law.  Plaintiff is the owner of a commercial property in Wilmington, Delaware, and Defendant is a special servicer that handles the default side of loan servicing for its affiliate.

Plaintiff requested that its loan be transferred to special servicing in anticipation of its large commercial tenant terminating the lease on the property.  Thereafter, the parties negotiated a Pre-Negotiation Agreement, after which time the parties engaged in settlement negotiations to purchase the loan on the property at issue.

Plaintiff filed a complaint seeking specific performance and injunctive relief, to compel Defendant to comply with the terms of the Pre-Negotiation Agreement contained in the parties’ Mortgage and Security Agreement to refinance existing debt on the property at issue.  Plaintiff asserted that the terms of the Pre-Negotiation Agreement were not upheld by Defendant.

The Court granted Defendant’s motion to dismiss, finding that there was no binding obligation in the Pre-Negotiation Agreement to negotiate.  Further, the Court rejected Plaintiff’s assertion that Defendant violated the implied covenant of good faith and fair dealing.  This is so because even if there was an obligation to negotiate, “such an obligation would be so inherently vague as to be unenforceable.”  Citing Maryland authority, the “overwhelming weight of authority holds that courts will not enforce an agreement to negotiate a contract.”

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.

Effective August 1, 2017, an amendment to Court of Chancery Rule 171(f) will go effective, setting forth word limitations for non-dispositive motions, and letters to the Court.  Under the amendment, motions filed with the Court–excluding those filed under Rules 12, 23, 23.1, 56 and 65, along with pre-trial and post-trial briefs–are subject to a more restrictive word count.  Motions impacted by this rule are to be filed without an opening brief, and may not exceed 3,000 words.  Oppositions likewise may not exceed 3,000 words, and replies shall not exceed 2,000 words.  The word limitation for motions filed under Rules 12, 23, 23.1, 56 and 65, along with pre- and post-trial briefs, remain the same (14,000 for opening and answering briefs, 8,000 for reply briefs).

In addition, the amendment changes the manner in which an attorney certifies compliance with the word count.  The word count must be stated in the signature block of the filed document governed by Rule 171(f), as opposed to filing a separate certification.

Finally, letters to the Court may not exceed 1,000 words. The amendment states that such letters should be used for “logistical and scheduling issues” and not for substantive relief.

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 a matter of first impression, the Court of Chancery considered whether an “unauthorized” act–one that the majority of stockholders entitled to vote deliberately declined to authorize–but that the corporation nevertheless determined to pursue, may be deemed a “defective corporate act” under Section 204 that is subject to later validation by ratification of the stockholders via Section 205 of the DGCL. Vice Chancellor Slights addressed this issue in the opinion of Nguyen v. View, Inc., C.A. No. 11138-VCS (Del. Ch. June 6, 2017).

In considering this question, the Court provided a helpful roadmap of opinions analyzing Sections 204 and 205 since the enactment of those statutes in 2014.  [For an earlier post discussing Sections 204 and 205, click here.]  Vice Chancellor Slights denied relief because the “unratified” corporate acts were unauthorized and rejected by the majority stockholder, as opposed to simply being defective.

The Court noted the difference between “failure of authorization” and “rejection” by stockholders. Neither the text of the statutes nor their legislative history lent support to usage of the statutes to ratify a corporate act that had been denied by the majority of a corporation’s stockholders.

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 a recent appraisal action before the Court of Chancery, In re Appraisal of SWS Group, Inc., C.A. No. 10554-VCG (Del. Ch. May 30, 2017), Vice Chancellor Glasscock found that the fair value of the acquired entity, SWS Group, Inc., (“SWS” or the “Company”), was less than deal price as a result of synergies between SWS and the acquiring company, Hilltop Holdings, Inc. (“Hilltop”).  Prior to the merger, SWS was a relatively small bank holding company.

Although the Court acknowledged that “a public sales process that develops market value is often the best evidence of statutory ‘fair value’”, what drove the Court to not rely upon deal price was its finding that “the sale of SWS was undertaken in conditions that make the price thus derived unreliable as evidence of fair value….”  Slip op., at 1.

Per the Court, the sale process of SWS was not a reliable proxy for statutory fair value because, among other things, “the probable effect on deal price of the existence of the [Hilltop] Credit Agreement under which the acquirer exercised a partial veto power over competing offers.”  Slip op., at 30.  Notably, neither side’s expert relied upon the deal price to determine fair value.

The Court was presented with competing discounted cash flow analyses from petitioning stockholders and the Company, along with a less frequently used comparable companies analysis provided by the petitioners.  The latter approach was rejected by the Court given that the sample of comparables chosen by the expert differed in significant ways.

In comparing the competing DCF analyses, the Court noted the way in which each side’s respective expert factored in the projections of the Company’s management.  In determining the appropriate cash flow projections, the Court of Chancery “has long expressed its strong preference for management projections.”  Slip op., at 32.

Of significance, respondent’s expert adopted management projections of the Company, while the petitioning stockholders’ expert made major adjustments to the projections, including extending the projections by two years.  The Court largely adopted the management projections with certain adjustments, which favored the Company’s DCF valuation.

The Court also analyzed the expert’s agreements over certain additional inputs, including equity risk premium, equity beta, and size premium.  After a careful consideration of each input, the Court determined that the fair value of the Company was $6.38/share, down from a merger price of $6.92/share.  Vice Chancellor Glasscock noted “that the fact that my DCF analysis resulted in a value below the merger price is not surprising: the record suggests that this was a synergies-driven transaction whereby the acquirer shared value arising from the merger with SWS.”

Key Takeaway: Appraisal actions in the Delaware Court of Chancery can come at real risk to petitioners when a robust sales process did not take place, management projections are significantly altered, and the sale included large synergies between the seller and acquirer that would be inappropriate to factor into the fair value of the entity.

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 PetSmart, Inc. appraisal proceeding, styled as In re Appraisal of PetSmart Inc., C.A. No. 10782-VCS (Del. Ch. May 26, 2017), the Delaware Court of Chancery found the deal price to be the fair value of PetSmart, Inc. (“PetSmart” or the “Company”), which was acquired as a going concern by a private equity acquirer.

Petitioners’ discounted cash flow valuation of the Company relied upon management projections, which is generally the preference of the Court.  However here, the Court determined the projections to be too optimistic about the future of the Company, and were “saddled with nearly all of the [ ] telltale indicators of unreliability….” Among other things, the Court found that the projections were prepared for the purpose of the sale process, rather than in the ordinary course.

Accordingly, Vice Chancellor Slights rejected Petitioners’ DCF valuation on that basis.  Rather, the Court held that a merger price “‘forged in the crucible of objective market reality,’ meaning that it was ‘the product of not only a fair sales process, but also of a well-functioning market,’” will generally be considered the best evidence of fair value of the Company.

Key Takeaway: The PetSmart decision,demonstrates that where a robust and competitive sale process exists, the deal price will be considered strong evidence of the fair value of a company. This is especially true when management projections lack sufficient reliability and cannot be relied upon to formulate a discounted cash flow analysis.

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.

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
Copyright: stuartburf / 123RF Stock Photo

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.

Beth B. Miller is counsel with the law firm of Fox Rothschild LLP, resident in its Wilmington office. She practices business, tax and trusts and estates law. You can reach Beth at (302) 622-4219 or at bbmiller@foxrothschild.com.

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.