Deleware Business Litigation Blog

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | May 16, 2012

Representing clients in class or derivative litigation is often tricky when a settlement is on the table. Your duty is to protect the class members or the entities that are your true clients.

But what happens when the class representative or nominal plaintiff does not agree with you? The usual solution to this dilemma, at least when considering a proposed settlement, is to take the dispute to the court for it to resolve. After all, the court will require that the class or other stockholders receive notice of the proposed settlement and will hear and decide any objection to it. What could be simpler?

As with many of life's problems, just transferring the decision to someone else only avoids coming up with a solution. The problem still remains. Moreover, consider what happens if the court, heaven forbid, agrees with the objectors. That will leave you with an unhappy client without a settlement, and with a case that you no longer believe will generate more for the client (and for you in fees) than is already available.

Nor is the court going to be happy with the choice you have forced on it. While all courts favor settlements, forcing a settlement over stockholder or class member objections is not pleasant.

To begin with, the objectors occasionally lack adequate legal representation and make hard-to-understand objections. But even when their objections are well-presented, the court is still faced with the difficult decision of whether to reject a settlement whose benefits may be lost at trial. Then the court will be blamed by the class members or stockholders who did not object to the settlement and who are now deprived of its benefits.

Last week, the Court of Chancery came up with an ingenious solution to this problem in Forsythe v. ESC Fund Management, Del.Ch. C.A. 1091-VCL (May 9, 2012). In Forsythe, the parties agreed to a $10.25 million cash settlement after years of hard-fought litigation. The settlement had much to recommend as a reasonable resolution. Most of the plaintiffs' claims had already been dismissed. The settlement was negotiated before a respected mediator. And, at one point, the named plaintiffs in this derivative action had agreed to the settlement. Only when they had second thoughts did they belatedly object to it. Finally, Vice Chancellor J. Travis Laster, who is no pushover for any hasty settlement, agreed that the settlement fell within a range of fairness that he would approve.

On the other hand, the court also recognized that the objectors had some arguments in their favor that, if accepted, meant the settlement was not enough for the claims they asserted. There were many objectors. Their arguments might generate a much larger recovery, if ultimately successful. The court too was aware that in such matters, the plaintiffs attorneys are incentivized to favor a settlement for the sure fees that will be won.

The court's solution was to let the objectors, in effect, buy the proposed settlement. If the objectors post a bond or similar security for the $10.25 million settlement on the table, the court will permit them to take over the prosecution of the litigation. That way, if the objectors fail to do better after a trial, at least the $10.25 million will be recovered. Will this proposal work?

We will see if a bond is posted. Certainly, as the court itself recognized, there are good reasons why even the most sincere objectors will not post such a bond. For example, if the objectors win after trial, they do not directly benefit from their victory. The recovery in this derivative litigation will first go to the company whose claims they assert. Only later will the recovery trickle down to the objectors, if at all. The cost of the bond may alone outweigh any benefit objectors eventually receive under those circumstances. On the other hand, much of the hard work of litigation has already been done and the possible recovery is quite large.

In some respects, the Forsythe facts present a unique set of circumstances more akin to those found in class action litigation. Unlike most derivative actions, the objectors in Forsythe expected any recovery to be distributed to them. The litigation concerned allegedly improper investments by defendants in controlling an investment fund the objectors invested in and from which they would receive distributions enhanced by any recovery by the fund in the litigation. That is closer to a class action where the class members recover directly in any settlement. This may lead to a "free rider" problem where objectors have little to lose by forcing class counsel to litigate to the bitter end and bear any costs involved. Hence, the court's solution to the balancing of parties' interests in Forsythe seems particularly appropriate.

In short, it remains to be seen if the Forsythe court's solution to the problem of "hated" settlements will actually work. At the least, it should quiet objectors who are unwilling to pay the price to continue litigation.

ASB Allegiance Real Estate Fund v. Scion Breckenridge Managing Member LLC, C.A. No. 5843-VCL  (May 16, 2012)

This is an excellent review of when a contract may be reformed by a court to correct a drafting mistake known by just 1 of the parties who remains silent in the face of the other party's obvious mistake about what the contract says.  Reformation is particularly appropriate when there is strong evidence from past dealings over what the parties intended to be in the contract and when the error makes no economic sense.

Forsythe v. ESC Fund Management Co. (U.S.) Inc., C.A. 1091-VCL (May 9, 2012)

When the Court tasked with reviewing a settlement proposal in a derivative action is faced with apparently well-intentioned objectors who want to go to trial and not settle, deciding what to do is not easy.  This decision comes up with an ingenious solution - let the objectors "buy the settlement."   This is accomplished by giving the objectors time to put up a bond to effectively guarantee the recovery of the settlement amount and then permit the objectors to take over the litigation and go to trial.

It will be interesting to see if the objectors take the Court up on its proposal.  After all, the recovery in any derivative suit goes first to the entity involved.  Any one who funds such litigation needs to be aware of the risk that sharing in the recovery is its only reward.

Protas v. Cavanagh, C.A. 6555-VCG (May 4, 2012)

This decision answers the question of what law will apply to decide if a beneficiary of a Delaware statutory trust may bring a derivative suit.  The court held that the established law under the DGCL and Rule 23.1 applies.  Hence, the beneficiary must show that either the director defendants are conflicted or that there is a substantial basis to believe that they will be liable because their actions are so outlandish that they are not protected by the business judgment rule.

Martin Marietta Materials Inc. v. Vulcan Materials Company, C.A. 7102-CS (May 4, 2012)

Non-disclosure agreements are often used and frequently ignored.  Well not any more.  This decision enjoins a proxy contest for 4 months because the bidder violated a NDA in its proxy materials.  This unique remedy will make it much more important to carefully draft and to honor NDAs.

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | May 2, 2012

In May 2010, the Delaware Supreme Court established its Complex Commercial Litigation Division. The CCLD is a true "business court," intended to supplement and complement Delaware's pre-eminent court for business disputes, the Delaware Court of Chancery. Since it was established, more than 100 civil actions have been filed in the CCLD.

Why a new business court when the Court of Chancery was so well respected? As a court with traditional equitable jurisdiction, the Court of Chancery does not permit jury trials or claims seeking only money damages. Hence, the common contract dispute between businesses often could not be litigated in the Court of Chancery and could never be tried to a jury. Instead, those cases had to be filed in the Delaware Superior Court, the Delaware trial court with general civil jurisdiction.

While the Superior Court handled those cases very well, the demands of modern litigation called for some changes in its practices. For example, electronically stored information (ESI) has grown so vast that the discovery process for ESI was often too expensive and time-consuming. Scheduling complicated business disputes in a court system already crowded with other civil and criminal matters was increasingly difficult. Delay was the result and all businesses hate those delays in resolving their disputes that so distract their employees and drain their resources. The time was ripe for change.

Out of this need, the CCLD was created. It has four experienced judges assigned to it who keep a case from beginning to end. The CCLD employs detailed scheduling orders whose timelines are meant to be kept, with cases tried in a year to 18 months. Special CCLD guidelines for addressing ESI discovery, attorney-client privilege disputes and expert testimony address three of the most contentious, expensive and time-consuming problems in modern civil litigation. The result is that cases are properly handled and trials scheduled.

Of course, as with any matter involving contentious parties, the course of litigation has not always been problem-free, even in the CCLD. This is to be expected when there is significant money at stake. That is always the case in the CCLD, whose jurisdiction is limited to matters involving at least $1 million in dispute. The judges of the CCLD recognize this and are determined to improve its processes. Hence, they are now inviting public input on how to improve the CCLD.

Since the idea of a CCLD took shape, the chief judge of the Delaware Superior Court has asked a committee of experienced Delaware lawyers to make suggestions on how the CCLD should operate. This CCLD committee periodically meets with the CCLD judges, both to provide comment on its practices and to hear the judges' thoughts on how litigation in the CCLD might be improved. The CCLD committee is scheduled to meet with the CCLD judges later this month and will welcome suggestions for the improvement of civil litigation in Delaware.

To prime your interest, here are a few areas of practice that might be addressed. To date, the CCLD has permitted the litigants to decide for themselves how strictly they want to follow the published CCLD guidelines on such matters as e-discovery and expert testimony. While the litigants have generally acted responsibly, there has been occasional, unnecessary squabbling. Should the judge insist their guidelines must be followed in such matters and no deviations be permitted?

After all, there is a good reason why every court has its Rules of Civil Procedure — to avoid inventing the rules for each new case. So long as there is some flexibility in how the rules are applied, new litigants are able to live with those rules. The CCLD decided not to adopt new rules of procedure, but instead to promulgate guidelines in those areas where the better course seemed to be to let sophisticated parties with much at stake set their own procedures. Is that still a good idea?

Scheduling orders are another potential area of some concern. One of the core principles of the CCLD is that it is bad for justice to be delayed. Yet too often lawyers request, even demand, extended periods to complete discovery and opportunities to brief and argue every issue. As a result, the judges are sometimes left with the difficult decision of whether to cut short the time one litigant pleads he or she needs to prepare his or her case. Should the CCLD nonetheless adopt strict scheduling timetables that will force lawyers to do what they must, when they must, to go to trial? After all, very short pretrial schedules are routine in a few "rocket dockets" and are often ordered in the Court of Chancery, where bet-your-company litigation is common.

If you have suggestions, comments or even complaints, send them to me as a member of the CCLD committee. You need not have litigated a case in the CCLD to make suggestions on how to improve the resolution of business disputes. To review the CCLD guidelines, visit its website at www.courts.delaware.gov/Superior/complex.stm. I will, in turn, guard your identity when I convey your messages to the committee as a whole. Remember, if you are not willing to help us improve, then you should not complain later.

Gearreald v. Just Care Inc., C.A. 5233-VCP (April 30, 2012)

This is an interesting appraisal case because it explains the issues dealing with valuing a smaller company.  As they are riskier, for example, a small company risk premium is proper in determining what its cost of capital should be.

Dawson v. Pittco Capital Partners L.P., C.A. 3148-VCN (April 30, 2012)

This is an interesting decision because it explains the limits of drag along rights.  While some old case law and some new contract language try to spell out when a stockholder, creditor or other interested party may have their rights affected by a corporate transaction taken without their consent, this makes it clear that there needs to be very explicit authority to do so, particularly when we are talking about drag along rights that are contractually based.

Authored by Katherine J. Neikirk
This article was originally published in the Delaware Business Court Insider | April 25, 2012

Assertion of attorney-client privilege requires careful judgment. On the one hand, not asserting attorney-client privilege can lead to charges of waiver or waiver. On the other, over-asserting attorney-client privilege can lead to expensive motion practice and anger courts.

Balancing these competing concerns can be even more difficult when the information withheld relates to facts. In E.I. Du Pont De Nemours v. Medtronic Vascular, C.A. No. N10C-09-058 (Del. Super. Ct. Mar. 13, 2012), a decision in a Superior Court complex civil matter, Judge Joseph R. Slights III addressed the assertion of attorney-client privilege where the documents at issue contained factual content. The court also addressed the privilege of communications with a former employee and whether a party must issue litigation holds to its independent auditors.

The dispute arose from a license agreement. Plaintiff E.I. DuPont de Nemours & Company sued defendant Medtronic Vascular for breaching a 1989 license agreement requiring Medtronic to pay DuPont royalties for certain products, according to the opinion. During discovery, disputes arose between the parties. Both parties moved to compel production of facts within attorney-client privileged documents. Medtronic also moved to compel production of communications with a former DuPont employee and responses to document preservation discovery relating to DuPont's independent auditors.

As the court recognized, the attorney-client privilege protects the giving of legal advice and the giving of information to lawyers in order for lawyers to provide legal advice. The attorney-client privilege does not, however, protect disclosure of underlying facts. The court emphasized the distinction between a fact, which is not subject to attorney-client privilege, and a communication concerning a fact, which may be subject to attorney-client privilege. A party cannot be compelled to disclose facts he or she communicates to his or her attorney in order to obtain legal advice, but a party can disclose facts he or she personally knows or facts known from other sources, even if those facts were disclosed to an attorney.

Applying these principles, the court denied DuPont's motion to compel production of an unredacted version of an email from Medtronic's former in-house counsel. The unredacted portion of the email reflected Medtronic counsel's summary of DuPont's position on royalties. Medtronic claimed this disclosure, as well as production of an email from a Medtronic financial analyst to Medtronic's chief patent counsel stating that DuPont had called demanding royalties, constituted a waiver of the attorney-client privilege, according to the opinion. With respect to the email from the financial analyst, the court found there was no waiver of the attorney-client privilege because there was no indication that the email sought legal advice. As far as the redacted email from Medtronic's counsel summarizing DuPont's position on royalties, the court concluded there was no waiver because the unredacted portion was simply a recitation of facts and there was no indication that the recitation of facts was necessary to facilitate the rendition of legal advice.

The court similarly denied Medtronic's motion to compel five documents that Medtronic claimed contained nonprivileged facts. Medtronic argued that it was entitled to discover relevant facts that might be contained within the documents and invited the court to conduct an in camera inspection of the documents. The court declined the invitation, describing as unfounded Medtronic's suspicions that DuPont had improperly withheld facts as opposed to communications concerning facts.

The court also denied Medtronic's motion to compel production of communications between DuPont attorneys and a former DuPont employee. Medtronic argued that the documents were not privileged because the former employee was not a client of DuPont's counsel at the time of the communications. The court concluded that the privilege log descriptions reflected that the communications related directly to knowledge obtained or conduct that occurred while the former employee worked at DuPont, so those communications were properly withheld.

Finally, the court denied Medtronic's motion to compel DuPont to provide witnesses who could testify about any litigation hold notices DuPont issued to two independent auditors it used for audits of Medtronic's royalty payments. The court concluded that such depositions would not lead to the discovery of admissible evidence because Medtronic had not identified any Delaware authority requiring DuPont to issue litigation holds to the auditors. The engagement letter with one of the auditors expressly provided that working papers created during the engagement were the property of the accountant, according to the opinion. Moreover, 24 Del. C. §120(a) provides that an accountant's work papers and other materials prepared by an accountant are the property of the accountant, absent an express agreement to the contrary. There was no such agreement here. Relying on the engagement letter and Section 120(a), the court concluded that the work papers and other documents prepared by the auditors were not within DuPont's possession, custody or control and therefore DuPont had no obligation to preserve these documents or authority to cause others to do so. DuPont was, however, required to produce documents it had provided to its auditors, if it had not already done so.

This decision offers useful guidance to practitioners asserting the attorney-client privilege in Delaware litigation. As the court recognized, the distinction between nonprivileged facts and privileged factual communications can be subtle. This decision illustrates that a party can disclose facts relayed to or by an attorney without waiving the attorney-client privilege, when those facts were not disclosed to facilitate the rendition of legal advice. This decision also stands for the proposition that Delaware law does not require companies to issue their auditors litigation hold notices for documents prepared by their auditors. It is important to note, however, that the Supreme Court and Court of Chancery have not yet addressed this issue.

Icahn Partners LP v. Amylin Pharmaceuticals Inc., C.A. 7404-VCN (April 18, 2012)

An advance notice bylaw requires stockholders to tell their company substantially in advance of a stockholders' meeting if they want to nominate someone to to be elected as a director at that upcoming meeting.  But, under the Hubbard decision, sometimes the Court of Chancery will set aside such a bylaw when it is used in a way the Court finds is inequitable.  Here Carl Icahn is claiming that the Board changed its basic business strategy after the advance notice bylaw deadline has passed and it would be inequitable under those circumstances to bar him from nominating a slate of directors to bring the company back on course.  The Court has agreed to hear his claim.  The outcome will be interesting.

Huffington v. T.C. Group LLC, C.A. N11C-01-030-JRJ-CCLD  (April 18, 2012)

Delaware has a savings statute that generally prevents the statute of limitations from expiring when a case is dismissed for technical reasons and then refiled in the right court.  But, as this decision points out, the savings statute has a much narrower scope than some might believe.  Thus, when as here, a case is filed in a jurisdiction other than that chosen by the parties in their contract and then dismissed for having violated the forum selection clause, the savings statute does not apply.

EMAK Worldwide Inc. v. Kurz,  No. 512, 2011 (April 17, 2012)

The Delaware Supreme Court has once again confirmed that substantial attorney fee awards may be appropriate even when the plaintiff has not won a large monetary recovery.  That is particularly so when the plaintiff has protected stockholder voting rights, as in this litigation.

The Delaware Chapter of the Federal Bar Association, in conjunction with the United States District Court for the District of Delaware, is pleased to announce another exciting new initiative.  On the evenings of Thursday, May 17 and Thursday, May 31, 2012, from 5:00 to 7:30 p.m., the District Court and FBA will sponsor a two-night seminar program entitled “The Federal Trial Practice Seminar Presents:  An Introduction to Federal Practice in the District of Delaware.”  The sessions will take place in Courtroom 2B at the J. Caleb Boggs Federal Building.

Attorneys who have been practicing in the District for three years or less are eligible to participate in this seminar.  One of the two seminar sessions will relate to an attorney’s interaction with opposing counsel and participation in the litigation process, while the other session will focus on an attorney’s interaction with the Court.  Each session will include a presentation from a speaker and a panel discussion.  The speakers and panel members will be current and/or former judges of the District Court.

Participation is limited to FBA members.  Current FBA members may register for the seminar by contacting Steve Brauerman via e-mail at sbrauerman@bayardlaw.com, by no later than May 14, 2012.  Those interested in participating in the seminar who are not currently FBA members may contact Mr. Brauerman at the e-mail address listed above to obtain additional information about FBA membership.

Space for the seminar is limited and applicants will be accepted on a first-come, first-served basis.  Applicants should be available to attend both sessions.  Admission to the seminar is free and the FBA expects to apply for Continuing Legal Education credit in Delaware for both sessions.

In re Answers Corporation Shareholders Litigation, C.A. 6170-VCN (April 11, 2012)

Directors who are also officers have an interest in a merger when they are to retain their jobs in the merged company.  Delaware has recognized that this interest is inevitable in many cases and is usually not enough to make that director's vote for the merger considered an interested transaction. Of course, if future employment is negotiated improperly, the director may well be "interested," particularly if he both negotiates the merger and his future employment at the same time.

But what happens if he does not do so? Here the director/officer was deemed to be an interested director who had to prove the entire fairness of the deal because he knew he was about to be fired unless the deal was done soon.  This illustrates the importance of context.

Finally, the opinion is also interesting for its review of when circumstantial evidence is enough to show the acquiror had knowledge of possible fiduciary duty breaches so as to be an aider and abettor.

Authored by Lewis H. Lazarus
This article was originally published in the Delaware Business Court Insider | April 11, 2012

When a defendant engages in arguably unlawful conduct, a plaintiff files an action to complain about and seek relief prohibiting the unlawful conduct, and the defendant thereafter changes its practices and moots the plaintiff's complaint, a plaintiff may be entitled to attorney fees based upon the benefit conferred. Absent such a rule, a plaintiffs counsel could undertake a contingent-fee case, incur fees to investigate and file the action and then wind up with no case and no compensation, even though the defendant had changed its practices in a manner consistent with the plaintiff's demand.

Even under this scenario, however, Delaware law requires that the action was meritorious when filed. For a derivative claim where a plaintiff does not make a demand upon the board, a complaint is not meritorious when filed if it is subject to dismissal because the plaintiff fails to plead the facts with sufficient particularity to demonstrate that demand was excused. As the plaintiff in Freedman v. Adams, C.A. No. 4199-VCN (Del. Ch.) learned in the March 30 opinion of Vice Chancellor John W. Noble, a plaintiff is not entitled to a fee if he or she fails in his or her derivative complaint to plead facts demonstrating compliance with Rule 23.1 of the Court of Chancery Rules, even if post-filing the defendant board members cause the corporation to alter its conduct in the manner sought in the complaint.

FACTUAL ALLEGATIONS OF FREEDMAN COMPLAINT

Plaintiff Susan Freedman complained in her Nov. 26, 2008, derivative action that the board of defendant XTO Energy Inc. breached fiduciary duties by paying cash bonuses to five executives in a manner that prevented the corporation from realizing a tax deduction for the payments, according to the opinion. The federal tax code permits cash bonuses to be deductible if they are performance-based and thus contingent upon the executive achieving performance goals that meet statutory requirements. The plaintiff pleaded that because the cash bonus payments did not comply with the applicable federal statute that allows for a company tax deduction, the corporation forwent approximately $75 million in tax deductions from 2005 to 2007, according to the opinion. Freedman sought an accounting for the losses sustained, a mandatory injunction requiring the board to formulate a tax-deductible bonus plan, an injunction against the payment of further non-tax-deductible compensation, and an award of attorney fees and expenses.

Approximately 10 weeks after the filing of the complaint, the defendant board adopted a cash-bonus plan that complied with the federal requirements for tax deductibility and submitted it to the stockholders for approval. On May 19, 2009, the stockholders approved the plan, according to the opinion. In early 2010, Freedman sold her shares and thereafter XTO merged with and into a subsidiary of Exxon-Mobil. On April 6, 2011, the parties stipulated to a dismissal of the action and thereafter the plaintiffs sought attorney fees of $1 million based on the benefit conferred of the corporation adopting a cash-bonus plan that permitted bonus payments to be tax-deductible.

COURT REJECTS PLAINTIFF'S ARGUMENTS

Freedman made three arguments as to why a majority of the nine-person board was either interested or not independent: First, that the five outside directors' compensation materially exceeds what is a usual and customary director's fee; second, that the outside directors received unusually large compensation as a quid pro quo for not implementing a tax-deductible cash bonus plan; and third, that the outside directors were actually employees controlled by the interested directors. The court rejected each of these arguments because the plaintiff failed to plead particularized facts to support her arguments. This failure is an abject lesson in the heightened pleading requirements of Court of Chancery Rule 23.1.

Among other lessons, the court's decision indicates that more than just large numbers is required to cause the court to conclude that a plaintiff has adequately pled a material conflict. Thus, outside director compensation of $678,555 to $792,198 in 2007, up from $459,676 to $516,860 in 2006, by itself did not suffice to show that the compensation exceeded what was usual and customary. Of particular significance was that XTO was a relatively large public company that had outperformed its peers in the S&P 500 Index and the Dow Jones U.S. Exploration and Production Index. Practitioners should note that the result might differ for a small, private company that underperformed in the market.

The quid pro quo allegation failed as well for lack of particularized facts. While the court acknowledged that the amount of compensation was larger than in a similar case where the court found sufficient allegations of quid pro quo, the plaintiff presented "no factual allegations from which the court could reasonably infer that the increases in the outside directors' compensation were related to the board's decision to not adopt a [tax-deductible] plan." The most glaring omission was the lack of factual allegations relating to the timing of the votes to increase the outside directors' compensation or the timing of these votes related to the board's decision not to implement a tax-deductible cash bonus plan. The court would not infer a causal connection merely from the general allegation that board compensation had grown during the time period that the board failed to adopt a tax-deductible cash-bonus plan.

The plaintiff's last argument, that the outside directors were controlled by the officer directors, also failed for lack of sufficient well-pleaded factual allegations. The new fact the court considered was the plaintiff's allegation that the outside directors spent significant time on projects assigned to them by the officer directors or people working under them. The court stated that it was "loath to make a ruling under which a board member's somewhat more active engagement in the management of a corporation's affairs may be seen as casting a shadow over that director's presumed loyalty." The court found the allegation of work assignments to be too vague as the plaintiff failed to allege what particular types of assignments the outside directors performed. The lack of particularized allegations precluded the court from inferring that the officer directors controlled the outside directors, according to the opinion.

Most notable in the court's rejection of the plaintiff's argument that the failure to adopt a tax-deductible cash-bonus plan reflected a lack of valid exercise of business judgment was the rejection of a fiduciary duty to minimize taxes. The court's words succinctly speak for themselves:

"Tax strategy is a complex, dynamic area of corporate decision-making that affects and is affected by many other aspects of a company. A company's tax policy may be implicated in nearly every decision it makes, including decisions about its capital structure, the legal forms of the various entities that comprise the company, which jurisdictions to form these entities in, when to purchase capital goods, whether to rent or purchase real property, where to locate its operations, and so on. Minimizing taxes can also require large expenditures for legal and accounting services and may entail some level of legal risk. As such, decisions regarding a company's tax policy are not well-suited to after-the-fact review by courts and typify an area of corporate decision-making best left to management's business judgment, so long as it is exercised in an appropriate fashion. This court rejects the notion that there is a broadly applicable fiduciary duty to minimize taxes, and, therefore, the plaintiff's argument that the board failed to act despite a duty to minimize taxes is unavailing."

LESSONS LEARNED

This case illustrates the importance of pleading particularized facts sufficient to demonstrate that the business judgment rule does not protect a board's decision. In the derivative context, if a plaintiff cannot show that a majority of directors was not disinterested or independent or that the decision was a not a valid exercise of business judgment, and the plaintiff did not first make a demand, the complaint will be dismissed under Court of Chancery Rule 23.1.

In that circumstance, the complaint was not meritorious when filed. That means that a plaintiff cannot recover attorney fees even if, after his or her action is filed, the board takes action that moots his or her complaint. Freedman is thus instructive for both plaintiffs and defendants counsel as to a plaintiff's entitlement to attorney fees if a complaint is susceptible to dismissal for failure to plead demand futility and the defendants after its filing act to moot the claims on the merits.

Shocking Technologies Inc. v. Michael, C.A. 7164-VCN (April 10, 2012)

A year or so ago, the DGCL was amended to permit the removal of a director by the Court of Chancery.  While the grounds to do are broadly stated (including "breach of the duty of loyalty"), the statute requires that the director first have been convicted of a felony or been found in a prior case to have breached his duty of loyalty.  There thus remains the question of whether director removal may be done without a prior action that establishes the grounds to do so.

This decision suggests that such a direct action for removal will be very hard to win, for the Court expressed serious concerns over whether it has that authority absent the statutory prerequisites. The question is still open to be squarely decided in another case.

Authored by Edward M. McNally
This article was originally published in the Delaware Business Court Insider | April 4, 2012

Recently, the Delaware Court of Chancery has found wrongful conduct but denied the remedy plaintiffs sought. The El Paso case is a prime example.

The court found the board of directors and, particularly, El Paso's president had failed to act properly in negotiating a merger. Even the company's investment bankers had a conflict of interests, yet, despite critical language in its opinion, the court refused to enjoin the merger.

Thus, stockholders on notice their interests had been harmed must wonder: "What do I do next?" A stockholder may well ask if he or she should accept what is offered in the merger or refuse the merger consideration to be entitled to damages later.

This is not an easy question to answer. In fact, a variation of this dilemma happens all the time. Consider the victim of an accident who is offered a settlement that is below what she feels is fair. American law forces her to make a hard decision - to take the money offered now or sue to try to get more in damages. She cannot do both, and if she wants to sue for more, she must forgo even the pittance offered now. Is that fair?

The standard justifications for this universal rule that forces a tough choice are that it encourages settlement and has a certain reciprocal aspect to it. After all, the wrongdoer is encouraged to offer enough to avoid potentially more costly litigation. Hence, all the leverage is not just on one side of the negotiations. Why then is that choice between taking the money now or forgoing it to sue not also a fair rule in stockholder litigation over a merger?

Indeed, some might argue that is the current law governing a stockholder class member's choice when faced with a merger achieved through known misconduct that goes through anyway. The stockholder has to choose whether or not to accept the merger consideration. There is case law that suggests that a fully informed stockholder who accepts what he or she is offered for his or her stock as a result of a merger is barred from taking the money and also continuing to seek damages for breach of fiduciary duty. That is definitely true for stockholders who might consider filing an appraisal action. They cannot both take the merger consideration for all their shares and sue for appraisal.

The recent decision by the Court of Chancery in In re Celera Shareholders Litigation, Del. Ch. C.A. 6304-VCP (March 23), addressed these issues. Celera was a class action in which the plaintiffs contended a merger was unfair to the class of stockholders who were to be cashed out in a merger. The class representative filed a motion to enjoin the merger, signed a preliminary settlement agreement just before the hearing on its motion, and then before the merger closed, sold his stock on the market for slightly more than the merger price. When another stockholder who objected to the settlement heard of the class representative's sale, it sought to disqualify the class representative on the grounds it no longer had any claim to settle, but had instead acquiesced in the merger.

The court held that the sale of the class representative's stock did not deprive it of its claim the merger was tainted by a breach of fiduciary duty. Hence, the representative still had a claim to settle and the court could then approve the proposed settlement for all the other members of the class. Though this procedural posture is unusual, the court's discussion of when a stockholder loses the right to continue litigating a claim for damages is instructive in more typical circumstances.

Space limitations here do not permit a full review of the extensive discussion of the reasoning in the Celera decision. What should be welcome is the court's sensitivity to the collective action problem confronting stockholders with real claims, but who are unable to stop a merger because most of their fellow stockholders want to take the money and move on.

The Delaware court recognizes that those stockholders who want to cash out for a premium over market should be able to do so. Hence, as in In re El Paso Shareholder Litigation, the court may refuse to enjoin the merger even if there is evidence of wrongdoing in the merger negotiations. If the stockholders who do take the money are then deemed to no longer be part of a class of stockholder claimants, the utility of the class action as a check on corporate insider abuse would be severely diminished. Indeed, that is why appraisal actions are fairly rare. Most stockholders, however reluctantly, just take what they are offered rather than go through the time-consuming and expensive appraisal process. As a result, there are often too few qualifying stockholders to make appraisal proceedings worthwhile.

To cut through these issues, the court in Celera set out the following rules that apply when stockholders are fully informed of any problems in a merger process, but when the merger is not enjoined: First, a stockholder must not vote for the merger or accept any tender offer for his or her stock prior to the merger if he or she wants to continue to seek damages. Second, a stockholder may accept the merger consideration and still retain his or her rights to seek damages in an action for breach of fiduciary duty, provided he or she has not voted for the merger. Third, acceptance of the merger consideration does constitute abandonment of appraisal rights. Hopefully, that is clear.

In Re K-Sea Transportation Partners LP Unitholders Litigation, C.A. 6301-VCP (April 4, 20120)

This is another example of how an LP agreement may limit the review of a transaction by a court at the request of a dissatisfied partner.  The partnership agreement provided that the GP only needed to act in good faith in approving a sale and defined good faith, in part, as established by reliance on an expert's advice.  Since that was present, the court dismissed the complaint.

Frank v Elgamal, C.A. 6120-VCN (March 30, 2012)

It is well understood that when a controlling stockholder stands on both sides of a transaction with his controlled entity that he will need to show the transaction is entirely fair to the other owners.  But when he receives such a special benefit so as to be on both sides of the deal is not always so easy to decide.  After all, it is common such acquirors to want to retain management.  If the insiders get an employment contract, do they stand on both sides of the negotiations?  This decision helps to answer that question.  In general, if the controllers get an equity interest in the surviving entity to a merger that is not shared with the other owners, then they are on both sides of the transaction and must show it is entirely fair.

Anguilla Re LLC v. Lubert-Adler Real Estate Fund IV LP,  Del. Super., C.A. N11C-10-061-MMJ-CCLD (March 28, 2012)

When must a litigant raise any issue over the choice of the law that governs a dispute?  Right away is the answer.  As this decision correctly holds, if the parties brief their issue under Delaware law, trying to argue later that some other jurisdiction's law applies is too late.