Delaware courts issued several important decisions in September implicating, inter alia, Section 220 requests for books and records, board of director fiduciary duties to oversee cybersecurity efforts, the business judgment rule, judicial dissolution, and corporate manager's implied consent to the jurisdiction of Delaware courts. The expedited litigation in Twitter v. Musk also kept the court busy in the run-up to the Oct. 17 trial in that matter.
Court Rejects Confidentiality of Financial Statements Sought by Section 220 Request
Hauppauge Digital, Inc. (HDI) "went dark" in 2014 after previously being publicly registered with the Securities and Exchange Commission. Afterward, HDI failed to provide shareholders with any financial information or hold any annual meetings. A shareholder sought to inspect HDI's books and records under Section 220 of Delaware's General Corporation Law for the stated purpose of valuing his shares. HDI accused the shareholder of an ulterior and harmful purpose for seeking its records and sought "the strongest possible confidentiality restrictions" that would last indefinitely.
The Court of Chancery initially referred the matter to a Master. The Master ordered HDI to produce its annual and quarterly financial statements for the period 2016-2020, but it subjected the records to a two-year confidentiality restriction. On review, the court rejected the Master's confidentiality restriction. HDI argued that the shareholder's potential disclosure of its financial statements to a competitor would be harmful. The Court of Chancery rejected this argument, finding it to be a formulaic reality "of doing business in a market economy." The court concluded that HDI "failed to point to a sufficient interest that could outweigh [the shareholder's] countervailing interest in valuing his shares."
Key Takeaway: Companies wanting to place confidentiality restrictions on records sought by Section 220 requests must show the threat of harm outweighs a shareholder's legitimate use, and general fears of disclosure to competitors are insufficient.
Reverse Spinoff Complies With MFW and Is Subject to the Business Judgment Review
Plaintiffs alleged direct and derivative claims against Match Group's board and controlling shareholder in connection with a reverse spinoff initiated by the controlling shareholder. Defendants moved to dismiss the plaintiffs' complaint.
The court initially decided that both plaintiffs lacked standing to bring derivative claims because both ceased to be shareholders of "Old Match." Plaintiffs could neither allege the transaction was perpetrated to deprive them of standing, nor that the transaction was a "mere reorganization" of Old Match. The court similarly concluded that the plaintiffs lacked standing to bring derivative claims on behalf of "New Match" because they did not own shares of New Match at the time of the alleged wrongdoing — "namely [during] the negotiation of the" transaction. Thus, the plaintiffs only had standing to pursue their direct claims.
The court also determined that the Delaware Supreme Court's MFW decision cleansed the plaintiffs' surviving direct claims. Under MFW, courts apply the business judgment rule to review a challenge to a conflicted controller transaction if the transaction satisfies six protections: (1) approval by a special committee and a majority of the minority stockholders, (2) an independent special committee, (3) advisors selected by the special committee, (4) a fair price, (5) an informed vote of the minority, and 6) no coercion. Plaintiffs conceded the first protection and failed to plead facts making it reasonably conceivable that the other protections were not met under the business judgment rule.
Key Takeaway: Plaintiffs face a steep challenge to plead sufficient facts to overcome the business judgment rule, and plaintiffs must act quickly to preserve derivative claims.
Sixteen Separate Opinions and Orders Issued in Twitter v. Elon Musk
Twitter and Elon Musk kept Chancellor McCormick busy in September. Between Sept. 2 and Sept. 28, the court issued 16 separate written orders and opinions on myriad discovery, pleading, and schedule matters. This work will culminate next month when the trial begins on Oct. 17, 2022. Highlights from the court's September work include:
- Ordering David Sacks — one of the four individuals identified by Elon Musk as persons with whom he privately communicated about the Twitter transaction — to comply with Twitter's subpoenas.
- Denying Elon Musk's request for reargument on the court's order denying his request to compel Twitter to collect documents using a more extensive date range. Musk argued the court could order Twitter to produce "narrow categories of 'low hanging fruit' from the expanded date range." The court correctly noted Musk did not ask for the "low-hanging fruit" when he argued his discovery motion: "Defendants overshot and asked for too much. That was a Mistake . . . Further reflection on the matter is not a reason for reargument; Defendants' more reasonable requests come too late."
- Granting Elon Musk's motion to amend his complaint to add allegations relating to Peter "Mudge" Zatko's whistleblower complaint, but denying his request to extend the case schedule by four weeks. The court permitted "incremental discovery" on the whistleblower's allegations, but rejected any changes to the Oct. 17, 2022 trial setting. The court noted: "Twitter 'has suffered increased employee attrition,' which 'undermin[es] the company's ability to pursue its operations goals. The company has been forced for months to manage under the constraints of a repudiated merger agreement, including Defendants' continued refusal to provide any consents for matters under the operating covenants.' I am convinced that even four weeks' delay would risk further harm to Twitter too great to justify."
- Granting in part Twitter's request for discovery sanctions against Musk. In one section, the court highlights some of Musk's failures: "Plaintiff's Fourth Discovery Motion identifies clear deficiencies in Defendants' document production. Third parties produced text messages with Musk that Musk himself did not produce, and Musk's own production of text messages revealed glaring deficiencies. As just one example, Defendants produced two texts sent to Musk from Robert Steel of Parella Weinberg Partners on June 17 at 9:57 a.m. and 10:15 a.m. The 9:57 a.m. text asks a question. The 10:15 a.m. text—stating "Ok. Got it. . . ." — implies that Musk responded. Assuming that Musk's response was not telepathic, one would expect some evidence of it in Defendants' document production. But Defendants provided none by the deadline for substantially completing document discovery."
- Granting in part Musk's request for additional discovery from Twitter. Specifically, Musk sought all Slack messages from 46 separate document custodians. In meet-and-confers, the parties' counsel attempted to negotiate a more limited set of custodians. Musk's final offer was for eight custodians; Twitter agreed to produce Slack messages for only six custodians. In his motion, Musk demanded that all 46 of Twitter's custodians produce their Slack messages. The court chastised Musk's position: "Defendants gave Plaintiff the impression that they were seeking limited Slack custodians, only to then say they never meant it. In this highly expedited case, there is no time for 'just kiddings.' Parties must be able to rely upon one another's good faith proposals for the discovery process to function."
- Denying Twitter's motion to compel production of attorney-client privileged communications Musk had with his lawyers while using his Tesla and SpaceX work emails accounts. Though a close call, the court ultimately found Musk has a reasonable expectation of privacy in his work emails based on affidavits submitted by the companies' IT departments.
Court Dismisses Caremark Claims Alleging Directors' Failure To Oversee Operations
Plaintiffs asserted Caremark claims against SolarWinds Corporation's (SolarWinds) corporate directors for failure to oversee the company's operations. SolarWinds was hit by Russian hackers who penetrated the company's computer systems and inserted malware. The hack damaged SolarWinds' customers and hurt the company's value. Plaintiffs alleged the directors failed to oversee the company's cybersecurity and sought to hold the directors individually liable for the damage.
The court dismissed the plaintiffs' claims. Directors are not personally liable for mere negligence or even gross negligence in violation of their duty of care. To survive a motion to dismiss, a plaintiff must allege a director's lack of oversight is so extreme that it represents a breach of the duty of loyalty. To do so, a plaintiff must allege a director's scienter — or bad faith — such that a director acted, or failed to act, "contrary to the corporate weal." Because the directors had ensured the company had a minimal reporting system about cybersecurity in place and because there were no red flags billowing about cyber threats, the plaintiffs' claims could not survive.
Key Takeaway: Caremark claims remain exceedingly difficult to make, even after the Delaware Supreme Court's decision in Marchand v. Barnhill.
Delaware LLC's General Counsel Impliedly Consented to Delaware Court's Jurisdiction
P3 Health was a Delaware limited liability company (LLC) owned by a private equity firm. P3 Health's owners sought to go public by merging with a Special Purpose Acquisition Company. Certain shareholders objected to the transaction, but the deal went forward. Plaintiff sued various defendants for breach of fiduciary duty in connection with the transaction.
One of the defendants was Jessica Puathasnanon, P3 Health's General Counsel. Puathasnanon asserted the Court of Chancery lacked personal jurisdiction over her.
The court easily rejected Puathasnanon's arguments and found she impliedly consented to service and jurisdiction in Delaware through her role as a senior manager of a Delaware LLC and her direct involvement in the underlying transaction. Section 18-109(a) of the Delaware Limited Liability Company Act establishes a mechanism for serving process and asserting jurisdiction on a manager of a Delaware LLC. As P3 Health's general counsel and chief legal officer, the court concluded that Puathasnanon "participated materially in the management" of P3 Health and the underlying transaction by directing Latham & Watkins' work.
Key Takeaway:Absent extraordinary circumstances, Delaware LLC senior managers will be subject to automatic service and the Delaware court's jurisdiction.
Removal of LLC's Manager and Minority Member Not Grounds for Judicial Dissolution
In March 2022, the majority members of a Delaware LLC removed a minority member and former manager through written consent. The minority member then brought a claim for judicial dissolution and winding up the LLC's affairs. The minority member asserted his removal had "led to irreconcilable differences among the members and managers." He also alleged he would "cause deadlock in future votes on matters requiring unanimous member consent."
The Court of Chancery granted the majority members' motion to dismiss. The court ruled that the "dysfunction and contrived deadlock complained of falls well short of the high bar to plead a claim for judicial dissolution." The court concluded that the complaint failed to adequately allege that it was not reasonably practicable for the LLC to carry on its business. Finally, the LLC agreement contained mechanisms to cure any future deadlock either through a buy-sell option or a contractual mechanism for dissolution.
Key Takeaway:A Delaware court will judicially dissolve an LLC only when the LLC's management has become so dysfunctional or its business purpose so thwarted that it is no longer practicable to operate the business.
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