The Herrick Advantage
This November, Herrick hosted several exciting events, including
one for emerging hedge fund managers. Herrick partner Irwin M. Latner joined our featured keynote
speaker, Michael Tew, Co-Founder and Partner, Quantx Management
LLP, and several panelists who talked about attracting early stage
capital, building infrastructure and developing sound operational
and risk controls.
Also this month, Herrick partners Irwin A. Kishner, Daniel A. Etna and Stephen D. Brodie spoke at our What's
the Catch? Minor League Baseball Team Acquisition and
Financing event. They joined our guest panelists, Stephen
Corcoran from Webster Bank, N.A., Larry Freedman from Mandalay
Baseball Properties and Larry Grimes of The Sports Advisory Group,
in a lively discussion about significant changes in Minor League
Baseball, which are resulting in escalating team purchase prices
and valuations.
SIFMA Puts Forth Guidance on a Collaborative Approach to Combating
Cyber Criminals
On October 20, 2014, the Securities Industry and Financial
Markets Association ("SIFMA") published Principles
for Effective Cybersecurity Regulatory Guidance (the
"Guidance") to emphasize cybersecurity as a top priority
for the financial industry and provide regulators and agencies with
the industry's perspective of how best to protect operations
and clients from cyber threats.
Currently, there is a proliferation of different government and
private sector security standards that creates confusion in the
industry and "fosters an environment in which noncompliance is
at risk." At the heart of SIFMA's Guidance, are the 10
"principles" it puts forth, intended to "facilitate
the dynamic partnership between financial regulators and industry
that is essential for each to achieve their shared goals of
protecting infrastructure and the assets and data of the
public."
The principles call for the harmonizing of regulations for greater
effectiveness and interagency cooperation. Throughout the Guidance,
SIFMA consistently advocates for the use and adoption of the
National Institute of Standards and Technology Cyber Security
Framework as a starting point for harmonizing regulations. It also
suggests the establishment of an interagency working group that
facilitates the coordination of ideas, standards and feedback
across all government and industry entities, to improve uniformity
in regulatory standards and foster public-private industry
collaboration.
The principles also emphasize the need for practicality and
flexibility in regulatory obligations. Protection standards cannot
be one-size-fits-all. Regulators need to remember that small,
medium and large-sized financial firms face different threats and
have different business models, resources and budgets. For
instance, SIFMA cautions that small and midsized firms often do not
have the resources to have in-house data storage and infrastructure
architects, often outsourcing these services to unregulated
third-party providers. The principles recommend increasing pressure
by regulators on providers servicing financial industry members to
meet regulatory standards. Any regulation or guidance needs to be
flexible to fit a wide range of firms and take into account
real-world applications.
Information sharing is another area the principles discuss.
Interagency and inter-industry knowledge sharing should be embraced
as threat trends and patterns can be more easily detected when
government and industry members collaborate in data and
infrastructure analysis. Additionally, if an attack were to happen
to one financial firm, it would be beneficial to alert other
similar firms susceptible to similar cyber-attacks and make known
how the attack occurred. However, strong privacy and oversight
protections must be built into the process for information sharing
to be an asset.
Furthermore, the principles encourage regulators to increase the
knowledge and skill of their examiners to match the new and
changing needs of the industry. In effecting this principle, FINRA
announced late last month that it is intensifying scrutiny of
cybersecurity practices at brokerage firms in 2015 by hiring
technology savvy examiners to help boost its efforts.
"Cyber-attacks are increasing in frequency and sophistication,
and it is critical that the industry and government collaborate to
mitigate these threats," states Kenneth E. Bentsen, Jr., SIFMA
president and CEO, emphasizing the importance of a collaborative
approach to cybersecurity. "We appreciate that the public
sector has embraced this partnership and we will continue to offer
our insights to help them in their work."
Delaware Court of Chancery Declines to Dismiss Fiduciary Claim
Against Directors for Waiver of Lock-Up
The Delaware Court of Chancery recently declined to dismiss a
claim brought by the shareholders of Zynga, Inc., a maker of online
social games, for breach of the fiduciary duty of loyalty against
four of the eight directors of the company for waiving a post-IPO
lock-up restriction that allowed the directors to sell some of
their stock in a secondary offering two months before the
expiration of the lock-up. As a result of the waiver of the
lock-up, the directors were able to sell a portion of their shares
at twice the price of the stock at the expiration of the lock-up
period, while other stockholders were still bound to the original
165-day lock-up. In declining to grant the motion to dismiss, the
Court held that it was reasonable to believe that the decision to
restructure the lock-up periods provided the directors engaged in
the restructuring an unfair benefit, thus constituting a
self-interested transaction. The Court also rejected the
defendants' argument that the directors' obligations only
arose pursuant to the contractual terms of the lock-up, and that no
fiduciary duty claims should be attached to the lock-up agreements.
In the other allegation in the suit, the Court granted the
defendants' motion to dismiss the claim of aiding and abetting
against Zynga's underwriters, holding that it could not be
reasonably inferred that the underwriters knowingly participated in
the directors' breach of their fiduciary duties.
Lee v. Pincus, C.A., No. 8458-CB (Del. Ch. Nov. 14,
2014)
Delaware Supreme Court Held UCC-3 Termination Statement
Effective Despite Mistake
In Official Comm. of Unsecured Creditors of Motors
Liquidation Co. v. JPMorgan Chase Bank, N.A., the Delaware
Supreme Court held that a termination statement is effective under
the UCC (and thus the financing statement to which the termination
statement relates ceases to be effective) if the secured party
authorizes the filing to be made. The Delaware UCC contains
no requirement that a secured party that authorizes such filing
subjectively intends or otherwise understands the effect of such
filing.
In 2008, a UCC-3 termination statement was filed with the Delaware
Secretary of State on behalf of General Motors Corporation
purporting to extinguish a security interest on the assets of
General Motors held by a syndicate of lenders including JPMorgan to
secure a $1.5 billion term loan. However, neither JPMorgan
nor General Motors subjectively intended to terminate the term loan
security interest when General Motors filed the termination
statement. After General Motors filed for reorganization
under Chapter 11 in 2009, a group of unsecured General Motors
creditors commenced a proceeding against JPMorgan seeking a
determination that the termination statement was effective
rendering JPMorgan an unsecured creditor on par with the other
unsecured creditors.
The Court held the UCC-3 termination statement effective and
explained that it is fair for sophisticated transacting parties to
bear the burden of ensuring that a termination statement is
accurate when filed. The Court further stated that it would
be inefficient for the UCC to make the effectiveness of a
termination statement depend on whether the secured party
subjectively understood the terms of its own filing or the effect
the filing would have on the security interest. The Court
emphasized that one of the most important roles the UCC plays is
facilitating the efficient procession of commerce by permitting
parties to rely in good faith on the plain terms of authorized
public filings.
Official Comm. of Unsecured Creditors of Motors Liquidation Co.
v. JPMorgan Chase Bank, N.A., C.A. No. 13-2187-bk (Del. Oct.
17, 2014).
Delaware Chancery Court Holds Financial Advisor Liable For
Aiding and Abetting Directors' Breach of Fiduciary
Duties
In a recent decision, In re Rural/Metro Corp. Stockholders
Litigation, the Delaware Chancery Court held a financial
advisor liable for $75.8 million in damages (representing 83% of
the total damages) for aiding and abetting breaches of the duty of
care by board members of Rural/Metro Corporation. The suit was
brought by stockholders of Rural/Metro Corporation in connection
with the sale of Rural/Metro Corporation to Warburg Pincus in 2011,
alleging that the company was sold at a price below its fair value
due to fiduciary duty breaches by the board and failure to make
material disclosures by both the board and its financial advisor,
RBC Capital Markets, LLC.
In an earlier decision, the Court determined that the shareholders
suffered $93 million in damages, representing the difference
between the value the shareholders received and Rural/Metro
Corporation's going concern value. All of the defendants other
than RBC entered into a settlement agreement. RBC subsequently
sought contribution from the director co-defendants with respect to
the damages awarded. Defendants who aid and abet a breach of
fiduciary duty are jointly and severally liable for resulting
damages. The Court held that under the Delaware Uniform
Contribution Among Tortfeasors Act (DUCATA), RBC's claim for
contribution was not, as the plaintiffs claimed, barred because RBC
committed an intentional tort. However, the Court stated that the
courts retain discretion to deny contribution under DUCATA if
warranted by the facts of the case. The Court then found that
RBC's contribution claim was barred by the equitable doctrine
of unclean hands, because RBC committed a "fraud upon the
board" by providing it with false information and failing to
disclose its conflicts of interest. The Court explained "if
RBC were permitted to seek contribution for these claims from the
directors, then RBC would be taking advantage of the targets of its
own misconduct."
DUCATA permits a finding of relative degrees of fault of joint
tortfeasors in determining their share of damages. In order
to qualify the directors as "joint tortfeasors," RBC had
to establish that directors breached their duty of loyalty - RBC
was only able to prove this for two directors who acted in a
self-interested manner. The Court apportioned 83% of the
damages to RBC, and the remainder to the two directors, finding
that a majority of the damages were attributable to failure to
disclose material information (for which RBC was solely
responsible), a lesser portion to breaches of duty in connection
with the approval of the merger (for which RBC could not seek
contribution due to unclean hands), and another portion to
initiating the sale process (for which RBC shared the damages with
the two directors).
In re Rural/Metro Corp. Stockholders Litigation,
C.A. No. 6350-VCK slip op. (Del. Ch. Oct. 10, 2014).
Delaware Chancery Court Offers Guidance on Dead Hand Proxy
Puts in Loan Agreements
The Delaware Chancery Court recently denied motions to dismiss
fiduciary duty claims against certain directors of Healthways, Inc.
and aiding and abetting claims against SunTrust Bank, the
administrative agent in connection with Healthways' credit
facility. At the heart of the Court's ruling was the
"dead hand proxy put" contained in Healthways' loan
agreement.
Healthways entered into a credit agreement in 2010 that contained a
"proxy put" provision pursuant to which a default would
be triggered under the credit agreement in the event that, during
any consecutive 24-month period, the Healthways board ceased to be
composed of continuing directors. Subsequently, Healthways
came under pressure from its stockholders and faced the risk of a
proxy contest. In 2012 Healthways and SunTrust added a
"dead hand" feature to the proxy put that treated
directors elected as the result of an actual or threatened proxy
fight, including directors elected by insurgent stockholders in
2014, as "non-continuing directors," even if such
directors were subsequently approved by the continuing
directors.
Pontiac General Employees Retirement System, a stockholder of
defendant Healthways, brought suit claiming (i) that individual
directors of Healthways violated their fiduciary duties by adopting
the dead hand proxy put in light of an identified stockholder
insurgency, the historical practice in the company's past
credit arrangements, and the alleged lack of informed consideration
and negotiation in connection with the dead hand proxy put feature
and (ii) that SunTrust aided and abetted the breach of those
fiduciary duties. The individual defendants moved to dismiss on the
grounds that the fiduciary duty claim was not ripe because the
proxy put had not been triggered and the debt had not yet
been accelerated. The Court, drawing comparisons to similar rulings
relating to poison pills, held that the fiduciary duty claims were
ripe for adjudication because the deterrent effect of the proxy put
and the fact that the non-continuing directors were treated
differently than other directors constitute present injuries.
SunTrust moved to dismiss the aiding and abetting claim on the
grounds that it didn't "knowingly participate" in the
breach of the fiduciary duties of the directors. The Court
dismissed SunTrust's motion holding that there is "ample
precedent" putting lenders on notice that proxy put provisions
are "highly suspect and could potentially lead to a breach of
duty on the part of the fiduciaries who were the counter-parties to
a negotiation over the credit agreement."
Even though the Court was ruling on motions to dismiss, borrower
and lenders should consider themselves on notice that the Chancery
Court will closely examine proxy puts, dead hand proxy puts, and
similar credit agreement provisions, that the deterrent effect of
such provisions may render a dispute ripe, and that such provisions
may give rise to a breach of fiduciary duty claim.
Pontiac General Employees Retirement System v. Healthways,
Inc., C.A. No. 9789-VCL (Del. Ch. October 14, 2014)
(transcript ruling).
Controlling Stockholder Must Have Conflict to Trigger
Entire Fairness
The Delaware Chancery Court recently dismissed a derivative suit
challenging the merger of Crimson Exploration, Inc., and Contango
Oil & Gas Co. The plaintiffs alleged that Crimson's largest
stockholder, Oaktree Capital Management, L.P., in conjunction with
other affiliates, constituted a control group, and breached their
fiduciary duties by selling Crimson at below market value, and in
consideration of side-benefits not shared with other stockholders.
The Court found that even if Oaktree did in fact occupy a control
position within Crimson's management, the complaint did not
allege facts sufficient to find that Oaktree was conflicted in the
transaction to rebut the business judgment rule. As such, the Court
declined to review the merger under the entire fairness standard
and dismissed the suit for failure to state a claim.
The plaintiffs contended that Oaktree, which owned 33.7% of
Crimson's common stock, should be considered a controlling
stockholder. Moreover, the Court found that the plaintiffs had
"hinted in the Complaint" that Crimson and its affiliates
constituted a control block. Absent the existence of a connection
in some legally significant way, the Court refused to treat Crimson
and its affiliates as a control group merely because of a mutual
alignment of self-interest. Delaware courts will only treat a
non-majority stockholder as a controller if they find that it
exercises actual control over the board's decision about the
challenged transaction. Although the Court was hesitant to conclude
that the plaintiffs did not meet their burden to allege that
Crimson was a controller in the pleading stage, it nonetheless
found that the "overarching theory that Oaktree sought to exit
its investment in Crimson, and, thus was willing to undersell its
shares," lacked any specific allegations from which the Court
could infer the existence of actual control.
The Court then determined whether Oaktree, as the assumed
controller, engaged in a conflicted transaction that would trigger
the entire fairness standard. In support of their allegation, the
plaintiffs argued that Oaktree received a combination of disparate
consideration for the merger through the prepayment of a loan, and
receipt of a unique benefit not shared by all stockholders through
a Registration Rights Agreement (the "RRA"). The Court
found that while Oaktree was the holder of a significant percentage
of a loan made to Crimson, there was no agreement to repay the debt
early as a condition of merger, and declined to view mere
anticipation of its repayment as equivalent to having a definitive
term in the merger agreement. Similarly, the Court found that the
RRA was neither a condition to merge, nor the product of a need for
liquidity, and thus could not be a "sufficiently unique
benefit" to implicate the entire fairness standard. The
Court concluded that the plaintiffs failed to rebut the business
judgment rule by creating a reasonable doubt that a majority of the
board was disinterested and independent, and dismissed the
action.
In re Crimson Exploration Inc. Stockholder Litigation,
C.A. No. 8541-VCP, 2014 WL 5449419 (Del. Ch. Oct. 24, 2014).
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