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
Copyright: bbourdages / 123RF Stock Photo

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.

In the recent decision of Kleinberg v. Aharon, C.A. No. 12719-VCL (Del. Ch. Feb. 3, 2017), the Court of Chancery appointed a custodian over a Delaware corporation under Section 226 of the Delaware General Corporation Law (“DGCL”) to break deadlock.  A voting agreement allowed for 6 board seats, 3 of which were controlled by Defendant Refeal Aharon, the founder and CEO of Applied Cleantech, Inc. (“Applied Cleantech” or the “Company”).  Aharon had traditionally appointed only 2 directors, but fearing that a 3-2 majority had formed against him, he appointed a 3rd director, which caused a 3-3 split on various issues at a meeting.

Under Section 226(a)(2), the court may appoint a custodian when:

The business of the corporation is suffering or is threatened with irreparable injury because the directors are so divided respecting the management of the affairs of the corporation that the required vote for action by the board of directors cannot be obtained and the stockholders are unable to terminate this division[.]

Notably, the custodian was appointed with limited powers.  In this regard, the Court cited to case law stating that the appointment of a custodian is not mandatory.  Accordingly, the Court appointed a custodian “with the power to vote as a seventh director and the authority to take additional steps to resolve the deadlock.”

For a prior post on a demand for the appointment of a custodian of a Delaware corporation, click here.

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.

Delaware follows the “American Rule”, which mandates that each party bear their own attorneys’ fees regardless of the outcome of the litigation.  However, as an exception to this rule, the court may order fee shifting if there is sufficient bad faith or litigation misconduct by a party.  The Delaware Supreme Court, in its recent decision of Shawe v. Elting, No. 487, 2016 (Del. Feb. 13, 2017), affirmed the Delaware Court of Chancery’s ruling granting such a fee award in light of the bad faith exception to the American Rule.

After an evidentiary hearing, the Court of Chancery found that plaintiff/appellant Shawe deleted substantial documents from his computer, recklessly failed to safeguard his cell phone, improperly gained access to Elting’s e-mails, and lied multiple times under oath. The court also found that Shawe’s improper conduct impeded the administration of justice, unduly complicated the proceedings, and caused the court to make false factual findings.  The lower court ordered that Shawe pay one-third of defendant/appellee’s Elting’s legal fees to defend the case on the merits, and 100% of Eltings’s fees to prosecute the award of sanctions. To review a blog summary of the Court of Chancery’s decision, click here.  The Court of Chancery’s decision can be found here.

The Delaware Supreme Court found that Shawe’s conduct was “ususually deplorable”, and affirmed the lower court’s findings. The High Court also noted that the Court of Chancery has broad discretion in fixing the amount of attorneys’ fees to be awarded, and absent a clear abuse of discretion, the Supreme Court will not reverse the award.

Key Takeaway: This is a textbook case of what actions a party should avoid during the course of litigation.  If the Court of Chancery finds that a party consistently lies under oath, has deleted evidence under a litigation hold notice, and other egregious misconduct, then such party will be susceptible to fee shifting and sanctions.

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 post-trial memorandum opinion of Dore v. Sweports, Ltd., C.A. No. 10513-VCL (Del. Ch. Jan. 31, 2017), Vice Chancellor Laster addressed indemnification for fees incurred in pursuing affirmative claims brought by an indemnified individual.  The underlying lawsuits giving rise to this indemnification action were substantially premised on the attempts of a law firm to collect legal fees.  A partner of the firm was also a director of the company, and had to defend himself when the company filed counterclaims against the plaintiffs that were unsuccessful.   This Delaware indemnification action was commenced after the lawyers substantially succeeded in collecting their fees, and in defending counterclaims brought by the company in the underlying litigation.

Of significance, the Delaware Court of Chancery addressed situations in which an affirmative claim is indemnifiable, in comparison to claims for indemnification for fees incurred to defend a claim brought against an individual “by reason of the fact” that they are a director or officer.

Vice Chancellor Laster explained:

[I]t is conceivable that indemnification might be warranted for preemptive litigation involving personal claims that sought to negate a threatened breach of fiduciary duty claim . . . . indemnification might be available if disposition of the personal claims would determine definitively whether the plaintiffs had breached their fiduciary duties.

Here, because the plaintiffs asserted breach of contract claims not related to their conduct as fiduciaries of the company, the Court declined to indemnify such claims.  The Court found that the contract claims were personal to the plaintiffs in their capacity as lenders, creditors and guarantors, claims which did not have a sufficient nexus to plaintiffs’ corporate duties.

However, the Court permitted indemnification of a portion of the fees incurred to defend against counterclaims that were successfully defended.  Finally, because the plaintiffs did not substantially prevail in their claims seeking indemnification, the court granted a small percentage of the “fees for fees” incurred in connection with this indemnification action.

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 very recent Delaware Supreme Court decision, Dieckman v. Regency GP LLC, et al., No. 208, 2016 (Del. Jan. 20, 2017), the High Court reversed the Court of Chancery and upheld claims based upon breach of the implied covenant of good faith and fair dealing.  The decision is noteworthy because the limited partnership agreement disclaimed fiduciary duties, and provided for conflict resolution safe harbors which defendants asserted were met.  However, the manner in which such safe harbors were obtained doomed defendants’ reliance upon the same.

Background

The plaintiff is a limited partner/unitholder in the publicly-traded master limited partnership (“MLP”). The general partner proposed that the partnership be acquired through merger with another limited partnership in the MLP family. The seller and buyer were indirectly owned by the same entity, creating a conflict of interest.

The general partner sought refuge in two safe harbor conflict resolution provisions contained in the limited partnership agreement: “Special Approval” of the transaction by an independent Conflicts Committee, and “Unaffiliated Unitholder Approval.” The former requires approval by a special committee independent of the sponsor and its affiliates review and make a recommendation to the board whether to approve the transaction.  The latter requires approval by a majority of unitholder unaffiliated with the general partner and its affiliates.  Under the Limited Partnership Agreement (“LPA”), if either safe harbor is satisfied, then the transaction is not a breach of the agreement.

Plaintiff brought a petition before the Court of Chancery challenging the propriety of the transaction.  Plaintiff alleged that the Conflicts Committee itself was conflicted.  Plaintiff also alleged that the unitholder approval was not satisfied because the general partner made false and misleading statements in a 165 proxy statement to secure such approval.  According to plaintiff, the proxy statement failed to disclose that the Conflicts Committee was not disinterested.

Defendants moved to dismiss the Chancery action, taking the position that the general partner need only satisfy what the partnership agreement expressly required—to obtain the safe harbor approvals and follow the minimal disclosure requirements. Defendants asserted that, whether the information contained in the proxy statement was misleading, or who served on the special conflicts committee, was immaterial based upon the literal reading of the LPA.

The Court of Chancery granted Defendants’ motion to dismiss, which prompted the appeal. Chancellor Bouchard found that fiduciary duties could not be used to impose disclosure obligations on the general partner beyond those in the LPA, because the LPA disclaimed fiduciary duties.  The Court of Chancery also found that the only express requirement contained in the LPA in the event of a merger was that the general partner provide notice of the merger agreement, and there was no requirement to provide notice of a conflict among the Conflicts Committee.

Analysis

The Supreme Court noted that the partnership agreement does not address how the general partner must conduct itself when seeking safe harbors contained in the partnership agreement. However, the Court found that where the express terms of the partnership agreement naturally imply certain corresponding conditions, unitholders are entitled to have those terms enforced according to the reasonable expectations of the parties to the agreement.

Specifically, the High Court stated:

The implied covenant is well-suited to imply contractual terms that are so obvious—like a requirement that the general partner not engage in misleading or deceptive conduct to obtain safe harbor approvals—that the drafter would not have needed to include the conditions as express terms in the agreement.

In other words, the general partner could not rely upon the safe harbor approvals, when it engaged in misleading or deceptive conduct to obtain such approvals, regardless of whether the LPA disclaimed fiduciary duties.

Key Takeaway

Although alternative entities may choose to waive fiduciary duties, the one duty that parties cannot waive in a Delaware alternative entity agreement is the duty to act consistently with the implied contractual covenant of good faith and fair dealing.  Moreover, once parties go beyond the minimal requirements set forth in safe harbor provisions, their actions and disclosures are likewise bound by the covenant.

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.