United States: Notable Delaware Decisions: First Quarter 2017

The Delaware Chancery Court and Delaware Supreme Court were busy during the first quarter of 2017, handing down decisions touching on:

• Required disclosure in a variety of settings – for standard-of-review "cleansing" purposes and appraisal notice purposes, and of financial advisors' analyses and potential conflicts of interest
• Merger agreement interpretation and breach
• Master limited partnership agreement interpretation and the implied covenant of good faith and fair dealing
• Board deadlocks, bad behaviors and remedies
• A few other interesting things – demand futility and board inaction, director-removal requirements, standing for books and records demands, and more contract interpretation and enforcement

Many of these decisions yield useful insights for practitioners and boards.

Disclosure Analyses

The Delaware Court of Chancery continues to confirm that a fully informed, disinterested and uncoerced stockholder vote can reduce the merger-challenge standard of review from entire fairness or Revlon's enhanced scrutiny to the business judgment rule, absent a controlling stockholder on the other side of the transaction or competing for consideration. Importantly, however, deficient disclosure or the presence of coercion will torpedo the cleansing effort. A lower level of disclosure can suffice for appraisal notice purposes, and disclosure regarding financial advisors' analyses and their potential conflicts of interest never slips far from view.

In re Solera Holdings, Inc. Stockholder Litigation, Court of Chancery, decided January 5, 2017:

• Granted motion to dismiss merger challenge, holding that transaction otherwise subject to Revlon enhanced scrutiny review would be reviewed under business judgment rule ("waste") standard because of approval by majority of fully informed, disinterested and uncoerced stockholders
• Observed that alleged disclosure deficiencies must be pled initially by plaintiff, following which defendant bears the burden of proving that the deficiencies are immaterial in order to obtain the cleansing effect from vote
• Confirmed long-standing Delaware law that the test of materiality of information is whether there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote, i.e., whether there is a substantial likelihood that it significantly alters the total mix of information made available

In re Merge Healthcare Inc. Stockholders Litigation, Court of Chancery, decided January 30, 2017:

• Granted motion to dismiss merger challenge, holding that transaction otherwise subject to entire fairness review based on director conflicts would be reviewed under business judgment rule ("waste") standard because of approval by majority of fully informed, disinterested and uncoerced stockholders
• Observed that alleged disclosure deficiencies must be pled initially by plaintiff, following which defendant bears the burden of proving the deficiencies are immaterial, in order to obtain cleansing effect from vote, citing Solera
• Explained that enhanced scrutiny and entire fairness review address agency problem arising from potentially divergent interests of stockholders (the owners) and directors (the agents), and that fully informed, disinterested, uncoerced stockholder vote ameliorates that problem
• Noted that even if large target stockholders were "controlling," their interests were aligned with other stockholders, obviating entire fairness review trigger arising from controlling stockholder status
• Declined to consider whether disclosure-based claims must be brought initially pre-closing, rather than post-closing (as was the case here)
• Confirmed long-standing Delaware law that the level of disclosure required of a financial advisor's analysis is "an accurate description of the advisor's methodology and key assumptions," that it need not include all data necessary for investors to make an independent determination of fair value, and that information that is "of interest" but not "material" need not be disclosed

In re Saba Software, Inc. Stockholder Litigation, Court of Chancery, decided March 31, 2017 (revised April 11, 2017):

• Rejected defendants' attempt to invoke business judgment rule (instead of Revlon) review for challenged sale of company based on "cleansing" stockholder vote, holding that vote was neither fully informed nor uncoerced, and denied director defendants' motion to dismiss
• Observed that failure to seek to enjoin merger vote based on disclosure deficiencies did not preclude making post-closing disclosure claims
• Confirmed that management projections, but not advisor-prepared projections, are material for merger vote purposes, and that requisite summary of banker's work need be sufficient only for stockholders to comprehend, not re-create, the analysis
• Found disclosure deficiency in failure to disclose why financial statement restatement had not been completed, as likelihood of completing restatement was material to evaluating alternatives to sale and restatement was a material assumption underlying projections; also found that that deficiency, and failures to disclose other alternatives and the likelihood of litigation over the discount-to-market merger price, undermined the cleansing effect of the stockholder vote
• Coercion found in board placing stockholders in situation of having to vote with no information regarding alternatives, leaving them no practical alternative but to vote in favor of sale regardless of its economic merits, notwithstanding that proxy statement's words and tone were neutral and nonthreatening
• Found adequate allegations of director bad faith and duty of loyalty breaches premised on directors' intent to secure personal benefits from sale (in the form of accelerated and cashed-out equity awards) that were material to them and not shared by stockholders generally

In re Columbia Pipeline Group, Inc. Stockholder Litigation, Court of Chancery, decided March 7, 2017:

• In order dismissing merger challenge and challenge to the adequacy of proxy statement disclosure for stockholder vote "cleansing" purposes, observed that alleged disclosure deficiencies must be pled initially by plaintiff, following which defendant bears the burden of proving the deficiencies are immaterial, in order to obtain cleansing effect from vote
• Confirmed materiality standard cited in Solera
• Noted, in the context of allegations that the entire board was motivated by conflicted self-interest, that the duty of disclosure requires disclosure of facts, not a "self-flagellating" drawing of conclusions that an investor "can readily stitch together" by inference from those facts
• Held that requisite "full" disclosure of investment banker compensation and potential conflicts in the merger context does not require disclosure of financial advisor positions that do not rise to the level of an actual conflict, and that disclosure is sufficient if information regarding such interests can be "min[ed]" from the advisor's own public filings

Vento v. Curry, Court of Chancery, decided March 22, 2017:

• Preliminarily enjoined buyer's stockholders' vote on merger approval because of inadequate disclosure of buyer's financial advisor's merger financing fee
• Rejected defendant's contention that investors could piece together the information from a table in the registration statement and a Form 8-K filed two months earlier, holding that disclosure is inadequate if the disclosed information is "buried" in the proxy materials and stating that investors "should not have to go on a scavenger hunt" for a complete picture of the advisor's financial interests in a transaction
• Contrast holding and analysis in (and absence of any reference in Vento to) March 7, 2017 Columbia Pipeline decision reviewed above

In re United Capital Corp. Stockholder Litigation, Court of Chancery, decided January 4, 2017:

• Rejected request for quasi-appraisal remedy based on alleged breaches of duty of disclosure in connection with a Delaware General Corporation Law (DGCL) §253 short-form merger
• Noted that DGCL §253 is designed to obviate entire fairness considerations and that, absent fraud or illegality, minority shareholder's only recourse is appraisal
• Held that disclosure required in short-form merger context is only of information material to deciding whether to seek appraisal, that providing information sufficient to calculate "fair value" is not required, and that 80-page merger notice (which included substantial process and financial information) was adequate

Merger Agreement Interpretation and Breach Analysis

Like golf shots and baseball games, no two merger agreement interpretations or analyses of covenant compliance are exactly alike. But those exercises can yield valuable clues for conducting the next effort and for negotiating and drafting to minimize ambiguities.

Shareholder Representative Services LLC v. Gilead Sciences, Inc., Court of Chancery, decided March 15, 2017:

• Found a contract term that had dual meanings in the biotechnology field "reasonably or fairly susceptible of different interpretations," and therefore ambiguous for purposes of determining whether a milestone payment was triggered
• Held that if a contract is ambiguous, the court may consider extrinsic evidence and must uphold, to the extent possible, the "reasonable shared expectations" of the parties at the time of contracting
• Considered, in choosing between the competing contract term meanings proffered by the parties, multiple merger agreement drafts, exchanged email and telephonic communications during the parties' negotiations, slide presentations and regulatory materials exchanged during the negotiations, the parties' conduct regarding the issue after closing and before the dispute arose, and the structure and operation of the agreement's milestone provisions as a whole

The Williams Companies, Inc. v. Energy Transfer Equity, L.P., Delaware Supreme Court, decided March 23, 2017:

• Upheld Delaware Court of Chancery decision that Energy Transfer Equity (ETE) could terminate its merger agreement with Williams, finding that while the Chancery Court had erred in analyzing whether ETE had breached its covenants to use "commercially reasonable efforts" to satisfy a tax opinion condition, and to use "reasonable best efforts" to consummate the merger, it had concluded properly that ETE had met its burden to show that any such breach did not contribute materially to the failure of that condition
• Strong dissent challenged the focus and adequacy of the Chancery Court's covenant-breach analysis, found that the Chancery Court had failed even to analyze whether the covenant breaches contributed materially to the failure of the condition, and cited numerous details in the record regarding the management and timing of relevant communications that suggested that ETE had worked actively to cause that failure

Master Limited Partnership Agreements and the Implied Covenant

Disputes concerning conflict of interest transactions involving master limited partnerships remain fertile ground for the intricate parsing of contract terms and the applicability (or not) of the implied covenant of good faith and fair dealing.

Dieckman v. Regency GPLP, Delaware Supreme Court, decided January 20, 2017:

• In reversing Court of Chancery decision, found that neither the contractual conflict committee approval safe harbor nor the contractual unaffiliated unitholder approval safe harbor was available to protect a merger with an affiliate from challenge
• Found that the implied covenant of good faith and fair dealing was well-suited to imply contractual terms that are so obvious – such as that a general partner may not engage in deceptive conduct to obtain contractual safe harbor approvals – that a drafter would not have needed to include them expressly
• Observed that the implied covenant is invoked, as in this case, when one party acts arbitrarily or unreasonably in conflict with the other party's reasonable contractual expectations

In re Energy Transfer Equity L.P. Unitholder Litigation, Court of Chancery, decided February 28, 2017:

• Denied cross-motions for partial summary judgment in matter arising from issuance of convertible units to some but not all unitholders in connection with financing a proposed merger
• Found that factual uncertainties regarding the composition and functioning of the contractual Conflicts Committee, and regarding the meaning of the undefined contractual term "distribution" in the context of the issuance of convertible units, required further development of the facts before any decision on the merits could be rendered

Brinckerhoff v. Enbridge Energy Company, Inc., Delaware Supreme Court, decided March 20, 2017:

• In reversing Court of Chancery decision, found that general "good faith" provisions of a limited partnership agreement do not override specific affirmative obligations
• Found that contractual "good faith" standard derives from contractual expression of standard of care rather than from corporate law waste principles, resulting here in bad faith being alleged sufficiently if accused general partner did not reasonably believe it was acting in the best interest of the partnership
• Observed that contractual "fair and reasonable" standard for approving conflicted transactions is "similar, if not equivalent to entire fairness review" in the corporate context
• Observed that reasonableness of general partner's reliance on financial advisor as professionally qualified within the contractual standard could be challenged by challenging advisor's methodology

Board Deadlocks and Bad Behavior

Setting up a business based on romance, or with a high risk of deadlock, can lead to unpleasant outcomes.

Shawe v. Elting, Delaware Supreme Court, decided February 13, 2017:

• Upheld Court of Chancery's order under Delaware's custodian statute, DGCL §226, to appoint a custodian to sell the business at issue, on the ground that it was suffering from irreparable injury because of divisions between the directors that the stockholders were unable to resolve
• Noted, after detailing examples of directors' extensive bad behavior that undermined employees' morale, that the sale remedy also was well-designed to protect nonshareholder constituencies, notably employees, by positioning the company to succeed
• Lengthy dissent took issue with custodian's ability to order sale of stock without stockholders' consent

Kleinberg v. Aharon, Court of Chancery, decided February 13, 2017:

• Held that appointment of a custodian was warranted in light of a board deadlock that stockholders could not resolve because of voting agreement constraints, which resulted in actual or threatened irreparable injury to the corporation arising from the CEO's increasingly erratic behavior
• Appointed a custodian with power to vote as the seventh director and authority to take additional steps to resolve the deadlock
• Noted, at relevant junctures, that a director cannot act by proxy, and that a chief executive officer may not act in a manner contrary to the express desires of the board of directors

Ensing v. Ensing, Court of Chancery, decided March 6, 2017:

• Granted declaratory judgments negating former husband's efforts to remove former wife as manager of LLCs, appoint himself as manager and transfer membership units to an entity under his control, all based on interpretation of the applicable LLC operating agreement
• Found that former husband had violated interim orders, sought rulings under false pretenses and introduced forged documents, and ordered him to pay a portion of former wife's litigation expenses
• Other Interesting Things – Demand Futility and Board Inaction, Director Removal, Books and Records Demands, and More Contract Interpretation and Enforcement

Horman v. Abney, Court of Chancery, decided January 19, 2017:

• Noted that to plead a claim based on board inaction, plaintiff must plead facts showing that directors acted inconsistently with their fiduciary duties of oversight (i.e., implementing systems and controls, and responding to evidence of corporate misconduct) and knew they were doing so
• Noted that exposure to "a substantial likelihood of personal liability" is the type of personal interest (in this case, self-preservation) that would disqualify a director from responding to a demand
• Held that plaintiffs did not plead that directors consciously failed to oversee the company's compliance with legal obligations, and therefore failed to plead demand futility adequately
• Cautioned plaintiff against conflating bad outcomes for the company and bad faith on the part of the board

Frechter v. Zier, Court of Chancery, decided January 24, 2017:

• Held that Section 141(k) of the DGCL unambiguously permits holders of a majority of a corporation's shares to remove directors with or without cause, and invalidated a bylaw purporting to require a 66 2/3% vote for removal

Weingarten v. Monster Worldwide, Inc., Court of Chancery, decided February 27, 2017:

• Held that Section 220(c) of the DGCL unambiguously requires that one filing a complaint to compel inspection of corporate records under Section 220 must be a stockholder at the time the complaint is filed, not just at the time the initial demand is made

Simon-Mills II, LLC v. Kan AM USA XVI Limited Partnership, Court of Chancery, decided March 30, 2017:

• In a wide-ranging contract interpretation case involving a call provision for which the electable exercise currency had disappeared, found that parties lacked meeting of the minds on a substitute currency, that the implied covenant of good faith and fair dealing could not be invoked to supply the missing term, and that the call right therefore could not be enforced
• Reviewed in detail when extrinsic evidence can be invoked to interpret a contract, what types of evidence may be considered, and Delaware's principles of contract interpretation
• Found that the implied covenant of good faith and fair dealing exists to handle developments and contractual gaps that neither party anticipated, but that the parties here knew about the currency issue and engaged in "gamesmanship and strategic silence" regarding the issue rather than dealing with it, thus negating application of the implied covenant
• Reviewed the distinction between material and immaterial contract breaches and available remedies for each under Delaware law

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.