United States: Herrick's December 2015 Corporate Alert Reports on Several Significant Delaware Court Rulings, the SEC's Decision to Allow the Issuance of Digital Securities and the SCOTUS Ruling on the Application of the Sovereign Immunity Doctrine

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In other news, Herrick's Sports Law Group continues to be at the forefront of the growing conversation about the fantasy sports industry. Next month in Dallas, corporate partner Daniel A. Etna will participate in a panel discussion at the Fantasy Sports Trade Association's 2016 Winter Conference. The panel, which will be moderated by Bloomberg News sports business reporter, Eben Novy-Williams, will address how fantasy sports business owners can attract investors in this uncertain time for the industry. For more information, please click here.

Financial Advisor Incurs Aiding and Abetting Liability in Connection with Buyout Transition

The Delaware Supreme Court upheld a ruling finding a financial advisor liable for aiding and abetting breaches of fiduciary duty by a target company's board of directors in connection with a $438 million buyout. The court, however, in so holding rejected the trial court's characterization of financial advisors as "gatekeepers" of the merger and acquisition process. The court emphasized that its holding is to be narrowly applied in the context of the specific facts of the case.

The trial court found that the financial advisor had misled the board of directors as to the target company's true value in order to quickly consummate the buyout transaction. The specific actions criticized by the trial court included the financial advisor: (i) allowing its interest in arranging buy-side financing to influence the conduct of the sale process, (ii) failing to inform the board of directors of its conflict of interest, and (iii) delivering a flawed valuation analysis immediately prior to the board of directors meeting convened to approve the buyout transaction.

On appeal, the financial advisor unsuccessfully argued that the trial court was mistaken in finding that it knowingly participated in the board of directors' breaches of fiduciary duty. The court ruled that the financial advisor knowingly induced the breaches by placing its conflict of interest ahead of the target company and providing fragmentary and misleading information. These acts were sufficient to establish that the financial advisor had acted with scienter—acting knowingly, intentionally or with reckless indifference and with an illicit state of mind.

RBC Capital Mkts. LLC v. Jervis, No. 140, 2015 (Del. Sup. Ct., Nov. 30, 2015)

Confidentiality Agreement Interrupts Hostile Takeover Bid

A California State court issued a preliminary injunction halting a hostile takeover bid after finding that the bidder had misused information in violation of a confidentiality agreement. The target company claimed that the bidder improperly used confidential product information in developing its hostile bid. Under the confidentiality agreement, the bidder was limited to using the confidential information of the target company (including product information) solely to evaluate its interest in pursuing a business relationship with the target company and for no other purpose.

The bidder unsuccessfully argued that the confidentiality restriction applied to a different transaction structure. Shortly after the court issued the preliminary injunction, the bidder abandoned its hostile bid. This ruling highlights that confidentiality agreements in merger and acquisition transactions can have significant unintended consequences.

Depomed Inc. v. Horizon Pharma, PLC, No. 1:15-cv-283834 (Santa Clara Cty., Nov. 19, 2015)

Delaware Chancery Court Denies "End Run" of Change of Control Provision

The Delaware Chancery Court ruled in favor of a bond trustee's claim that a restructured stock acquisition caused the breach of an indenture covenant requiring the repurchase of $600 million of bonds. The stockholder initially agreed to pay $1.39 billion to acquire 80% of the voting rights of the issuer. The acquisition was subsequently revised to provide for the stockholder to pay $1.37 billion to acquire (i) 34% of the voting rights of the issuer and (ii) an option to acquire an additional 46% voting interest in the issuer for an exercise payment of $25 million.

Under the original acquisition structure, the shareholder would have obtained a controlling stock in the issuer thereby triggering a change of control provision contained in the issuer's bond indenture. Under this provision, the issuer or the shareholder would be obligated to buy back $600 million of bonds at 101 cents on the dollar. The bond trustee successfully argued that the acquisition structure had been revised in order to avoid triggering the change of control provision. The court found that the revised acquisition structure reflected the fact that the stockholder acquired "de facto" control of the issuer.

Wilmington Savings Fund Soc'y FSB v. Foresight Energy LLC, No. CA 11059 (Del. Ch. Ct., Dec. 4, 2015)

SEC Permits Issuance of Digital Securities

Overstock.com, Inc. has received permission from the Securities and Exchange Commission to issue public securities in digital format using the blockchain, an online ledger supporting the bitcoin digital currency. Digital securities have the same rights, preferences and privileges as traditional securities of the same class, but settle differently than traditional securities. Digital securities are uncertificated, registered securities, the ownership and transfer of which are recorded on a proprietary ledger that will be publicly distributed. The validity of publicly available copies of the ledger can be mathematically proven utilizing cryptographically-secured distributed ledger network technology.

Unlike traditional securities, digital securities will settle nearly instantaneously as the trade is the "settlement." In addition, trades of digital securities do not require the involvement of a central depositary, such as DTC's Cede & Co., which holds physical securities on behalf of record holders. Rather, digital securities will be directly held and traded by their beneficial owners on the proprietary ledger.

Overstock.com, Inc., 424(b)(3) Prospectus (Reg. No. 333-203607, Dec. 9, 2015)

New York Appellate Court Recognizes Exception to Attorney-Client Privilege

The New York Appellate Division, First Department, recognized for the first time a fiduciary exception to the attorney-client privilege. The exception was recognized in connection with a dispute among the managers of an operating company, the law firm for the operating company and the operating company's major investor. The law firm refused to disclose documents to the investor on the basis of the attorney-client privilege. The investor argued that it was entitled to disclosure as an intended beneficiary of the law firm's advice to the operating company's managers.

The court ruled that when management actions are challenged by the owners a fiduciary exception to the attorney-client privilege is available upon a demonstration of "good cause."

For purposes of determining "good cause," the court adopted a multi-factor test formulated by the U.S. Court of Appeals for the Fifth Circuit in the 1970 case Garner v. Wolfinbarger. The court in Garner provided the following non-exclusive list of considerations for determining "good cause:"

  • the number of shareholders and percentage of stock they represent;
  • the bona fides of the shareholders;
  • the nature of the shareholders' claim and whether it is obviously colorable;
  • the apparent necessity or desirability of the shareholders having the information and the availability of it from other sources;
  • whether, if the shareholders' claim is of wrongful action by the corporation, it is of a criminal nature, or illegal but not criminal, or of doubtfully legality;
  • whether the communication relates to past or prospective actions;
  • whether the communication is of advice concerning the litigation itself;
  • the extent to which the communication is identified versus the extent to which shareholders are blindly fishing; and
  • the risk of revelation of trade secrets or other information in whose confidentiality the corporation has an interest for independent reasons.

The court ruled that, in order to properly apply the fiduciary exemption, a comprehensive "communication-specific" analysis must have been conducted by the court.

NAMA Holdings, LLC v. Greenberg Traurig, LLP, Index No. 601054/08, 2015 Slip Op. 07346 (N.Y. App. Div., 1st Dept., Oct. 8, 2015)

U.S. Supreme Court Rules on Application of Sovereign Immunity Doctrine

The U.S. Supreme Court provided guidance as to when the commercial activities of a foreign state-owned entity are sufficient to deny such entity the benefits of sovereign immunity as provided for under the Foreign Sovereign Immunities Act (the "FSIA"). The FSIA denies sovereign immunity for claims arising out of commercial activities conducted in the United States.

The case before the Court arose out of a personal injury claim brought by an American tourist against a state-owned Austrian railway. The tourist was travelling on the Austrian railway with a Eurail pass purchased from a travel agent based in Massachusetts. The U.S. District Court dismissed the claim on the basis of sovereign immunity. On appeal, the U.S. Court of Appeals for the Ninth Circuit ruled that the sale of the Eurail ticket was imputable to the Austrian railway under traditional agency doctrine. Thus, the Austrian railway was found to have engaged in commercial activity in the United States under the FSIA.

The U.S. Supreme Court reversed the U.S. Court of Appeals decision by focusing upon whether the personal injury claim was based upon the degree of the Austrian railway's alleged commercial activity in the United States. The Court ruled that the United States commercial activity needed to be the "core" activity of the lawsuit. In refusing to deny the application of the FSIA, the Court found that the core activities of the tourist's lawsuit "plainly occurred abroad." The purchase of the Eurail pass in Massachusetts was just one ancillary element of such lawsuit.

OBB Personenverkehr AG v. Sachs, 136 S. Ct. 390 (U.S. Sup. Ct., Dec. 1, 2015)

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