United States: Delaware Discourages Appraisal Arbitrageurs (March 2015 Corporate Alert)

The Herrick Advantage

Herrick Corporate partners Irwin A. Kishner and Daniel A. Etna recently advised longtime client Legends Hospitality in a major strategic partnership with concert and entertainment giant Live Nation. The deal, which has Legends operating food and beverage services at 34 of Live Nation's music venues in North America, is one of the largest venue food and beverage contracts in history.



Delaware Discourages Appraisal Arbitrageurs

The Delaware Supreme Court recently affirmed the Chancery Court's ruling in Huff Fund Investment Partnership v. CKx, Inc., in a decision that could potentially slow the surge in appraisal proceedings. In Huff Fund, two bidders expressed an interest in acquiring CKx. One bidder, a private equity fund, bid $5.50 per share and the other bidder, unidentified, bid $5.60 per share. CKx accepted the lower bid because CKx knew that the higher bidder had not yet obtained the financing to close the deal. Huff Fund Investment Partnership, was among the investors that petitioned for appraisal, claiming that the fair value of the company is higher than the deal price. Vice Chancellor Sam Glasscock III held that the deal price was the most reliable and probative indicator of fair value and rejected each party's expert valuations. Earlier this year, Vice Chancellor Glasscock similarly held in In re Appraisal of Ancestry.com that the fair value is "best represented by the market price." The Delaware Supreme Court's decision in Huff Fund affirms Vice Chancellor Glasscock's holdings in both Huff Fund and Ancestry.com.

This decision may subdue the recent upward trend of appraisal proceedings. Companies in recent years have been spending millions of dollars in defense costs due to appraisal litigation initiated by hedge funds. In addition to CKx and Ancestry.com, Dole Food Co. has also recently battled appraisal suits. This prompted Dole's President to propose to the Delaware legislature a bill to restrict such suits and a threat to take its business out of the state if the laws did not change. The Dole proposal would limit appraisal challenges to investors who held shares before a takeover announcement and would lower the current statutory interest payout of 5.75%.

Huff Fund Investment Partnership v. CKx, Inc., Civil Action No. 6844-VCG

Delaware Focuses on Fee-Shifting Bylaws

The Delaware courts and state legislature are addressing the ramifications of last year's Delaware Supreme Court decision in ATP Tour, Inc. v. Deutscher Tennis Bund, upholding the facial validity of a fee-shifting bylaw in a non-stock corporation as a matter of contract law.

In Strougo v. Hollander, the Delaware Chancery Court recently held that a non-reciprocal fee-shifting bylaw, adopted after a plaintiff's interest in the corporation was eliminated in a reverse stock split, could not bind a stockholder challenging the fairness of the transaction. On May 30, 2014, First Aviation Services, Inc. ("First Aviation") consummated a 10,000-to-1 reverse stock split, the effect of which was to involuntarily eliminate the interests of certain stockholders and make First Aviation a privately-owned company.  Shortly thereafter, on June 3, 2014, the board of directors of First Aviation adopted a fee-shifting bylaw that was admittedly modeled after the bylaw at issue in ATP Tour.  First Aviation's bylaw provided that it would apply to "any current or prior stockholder . . . [who] does not obtain a judgment on the merits that substantially achieves . . . the full remedy sought . . . ".  On June 14, 2014, the plaintiff, on behalf of himself and a class of former stockholders that were similarly cashed out, sued First Aviation and its directors challenging the fairness of the reverse stock split, and later amended the complaint to challenge the bylaw provision.  In the instant case, the court only decided whether the bylaw was applicable to the former stockholder.

Delaware courts view bylaws as "an inherently flexible contract between the corporation and its stockholders," thus, the court began its analysis under contract law principles. Accordingly, the court reasoned that "a stockholder whose equity interest is eliminated is equivalent to a non-party to the corporate contract, meaning that a former stockholder is not subject to, or bound by, any bylaw amendments after one's interest in the corporation has been eliminated." Rather, the bylaws in effect at the time of the cash-out transaction would bind the stockholder who challenges the transaction post- closing.  Furthermore, the court held that the plain language of the Delaware General Corporation Law ("DGCL") contemplates that the term "stockholder" refers only to current stockholders, and "not to former stockholders who no longer have an equity interest in the corporation."

Earlier this month, the Corporation Law Council of the Delaware State Bar Association (the "Council") proposed two amendments to the DGCL that, if enacted, would prohibit fee-shifting provisions in both the certificate of incorporation and the bylaws. As the council reasoned, the widespread adoption of fee-shifting provisions would make "stockholder litigation, even if meritorious, untenable" because few stockholders would accept the risk of litigation if it meant "exposure to millions of dollars in attorneys' fees to attempt to rectify a perceived corporate wrong, no matter how egregious."

Strougo v. Hollander, C.A. No. 9770-CB WL 1189610 (Del. Ch. March 16, 2015)

Delaware Chancery Court Addresses Arbitration Provision

In 3850 & 3860 Colonial Blvd., LLC v. Griffin, the limited liability company agreement of Rubicon Media, LLC provided that disputes would be resolved by arbitration.  Rubicon Media, LLC was subsequently converted into a corporation and its certificate of incorporation implemented a litigation-only approach for disputes. Members of Rubicon brought suit in Delaware Chancery Court, alleging breaches of fiduciary duties, among other things. Rubicon asserted that the Court lacks subject matter jurisdiction because the parties agreed in Rubicon's LLC agreement to submit all disputes to arbitration.

Whether parties have an agreement to arbitrate "is generally a decision for a court," and there is a presumption that parties intended "issues of substantive arbitrability to be decided by a court." This presumption can be rebutted with evidence that parties "clearly and unmistakably" intended otherwise. A previous case, Willie Gary (906 A.2d 76, 19 (Del. 2006)), established that this evidence is found where an arbitration clause generally provides for arbitration of all disputes and also incorporates a set of arbitration rules that empower arbitrators to decide arbitrability. However, even if those two elements are satisfied, the Court must resolve issues of substantive arbitrability if the party seeking to avoid arbitration makes "a clear showing that its adversary has made essentially no non-frivolous argument about substantive arbitrability."

Here, the Court found that the arbitration provision in the Rubicon LLC agreement meets both prongs of Willie Gary - it applies to "any dispute arising under or relating to" the LLC agreement and, by stating that arbitration will be governed by the Commercial Arbitration Rules of the American Arbitration Association, empowers an arbitrator to rule on jurisdiction. The Court also found that Rubicon has a non-frivolous argument for arbitration since it is unclear whether the plaintiff's claims arise out of the LLC agreement or the certificate of incorporation and, therefore directed the case to an arbitrator to decide the issue of arbitrability.

The Court also addressed the issue of whether Rubicon Inc. could be required to arbitrate based on a provision in a contract to which it is not a signatory. The Court relied on its previous ruling in Bernstein v. TractManger, Inc. (953 A. 2d at 1005) that "rights created by an LLC's operating agreement may be enforced against the corporation into which the LLC was converted." The Court also noted that requiring arbitration of claims involving affiliates of signatories is "not unusual." Therefore, the Court held that requiring Rubicon Inc. to arbitrate is permissible and not inequitable.

3850 & 3860 Colonial Blvd., LLC v. Griffin, C.A. No. 9575-VCN, (February 26, 2015)

NJ Courts Will Not Enforce Unclear Arbitration Provisions. Will SCOTUS Weigh In?

This spring, the United States Supreme Court ("SCOTUS") may take up U.S. Legal Services Group v. Atalese, a case decided by the New Jersey Supreme Court ("NJSC") in September of 2014.  In Atalese, the NJSC held that an arbitration provision providing that disputes "shall be submitted to binding arbitration" was not enforceable in New Jersey, unless such an arbitration provision was accompanied by language that is unambiguous and sufficiently clear to a reasonable consumer and states that the party was waiving its statutory right to seek relief in a court of law.

In January, the defendant in Atalese filed a petition of writ of certiorari with SCOTUS. In late February, several amicus briefs, including an amicus brief of the Chamber of Commerce of the United States of America and the New Jersey Civil Justice Institute were also filed with SCOTUS. The petitioner and the amicus curiae generally argue that, among other things, the NJSC's decision in Atalase should be overturned because it is in conflict with the Federal Arbitration Act, which requires parties that have executed agreements containing arbitration clauses to arbitrate instead of seeking relief in a judicial forum. The petitioner points to SCOTUS' decision in Doctors' Associates v. Casarotto. In Casarotto, SCOTUS overturned a decision of the Montana Supreme Court which had upheld a notice requirement for all agreements containing an arbitration provision. In their opinion, SCOTUS noted that Congress "precluded states from singling out arbitration provisions for suspect status" when it passed the Federal Arbitration Act. Essentially, SCOTUS held that state courts may not invalidate arbitration provisions under state laws that treat arbitration provisions different from other contractual provisions.

The decision in Atalese may threaten small businesses with burdensome litigation costs in the event of a dispute if they have contracted with customers in New Jersey and expressly agreed to arbitrate. Unless, SCOTUS decides to review and overturn Atalese, the ruling in that case will remain the law in New Jersey.

Atalese v. United States Legal Services Group, L.P., 219 N.J. 430 (2014)

New York Attorney General's Proposed Financial Frauds Whistleblower Act

New York Attorney General Eric T. Schneiderman is proposing legislation in Albany to protect and reward employees who report information about illegal activity in the banking, securities, and insurance and financial services industries.  The proposed legislation, "Financial Frauds Whistleblower Act," would provide financial compensation to whistleblowers that voluntarily provide original information, not previously known to the Attorney General, which leads to more than $1 million in penalties and settlement proceeds for financial fraud or misconduct. The Act would also protect whistleblowers against retaliation by current and prospective employers.  In 2010, the New York State False Claims Act was amended to include incentives and protections for whistleblowers who report abuses of taxpayer funded state expenditures. However, no law currently exists in New York State to protect or incentivize whistleblowers who report securities or financial frauds.

The rewards to whistleblowers would not be drawn from state funds, but from monetary recoveries from wrongdoers.  Whistleblowers would receive 10% to 30% of the money obtained in a fraud case. Additionally, the proposed legislation would create significant incentives for employees to provide information to the Attorney General rather than reporting such information internally. The Financial Frauds Whistleblower Act is similar to the whistleblower program that was created under the Dodd-Frank Act. However, the SEC has previously explained that such whistleblower programs encourage whistleblowers to first report any misconduct internally, a factor which the SEC considers when determining the amount of the monetary award. Accordingly, the expectation was that directors would foster a culture that affirmatively encourages employees to report any wrongdoing without any fear of retaliation. As for New York, we have yet to see the proposed text of the Financial Frauds Whistleblower Act, and, if adopted, the effect it will have in the corporate governance of companies.

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