Wilmington, Del. (January 17, 2024) - Delaware courts issued many important corporate and commercial decisions in 2023, including rulings by the state high court that clarified the test for analyzing board actions in the context of contested director elections, and clarified the limits of judicial equitable review of LLC agreements.
In the first part of a two-part series, we examine these and other impactful decisions from last year.
Did Delaware Supreme Court Merge the Blasius and Unocal Standards in Recent Decision of Coster v. UIP?
In Coster v. UIP, 300 A.3d 656 (Del. 2023), the Delaware Supreme Court approved the Court of Chancery's combination of Unocal's nexus test with Blasius's compelling justification requirement, affirming the holding that: "To satisfy the compelling justification standard, 'the directors must show that their actions were reasonable in relation to their legitimate objective, and did not preclude the stockholders from exercising their right to vote or coerce them into voting a particular way."
The Court of Chancery, noting the case's "exceptionally unique circumstances," articulated that "in this context, the shift from 'reasonable' to 'compelling' requires that the directors establish a close fit between means and ends." The Delaware Supreme Court agreed, concluding that courts can apply Unocal "with the sensitivity Blasius review brings to protect the fundamental interests at stake—the free exercise of the stockholder vote as an essential element of corporate democracy."
Supreme Court Clarifies Limits of Judicial Equitable Review of LLC Agreements
In Holifield v. XRI Investment Holdings, 2023 Del. LEXIS 295 (Del. Sept. 7, 2023), the Delaware Supreme Court upheld an LLC agreement's incurable voidness provision. The provision at issue rendered void — not just voidable — any transfers of interest that were in violation of the LLC agreement. The court emphasized that Delaware law affords parties to alternative entity agreements maximum private ordering and contractual freedom. Though it rejected the notion that parties must use "talismanic magic words," the court concluded that the plain, unambiguous language of the LLC agreement indicated that sophisticated LLC members bargained for an enforceable clause voiding non-compliant interest transfers, incapable of being cured — even by a court of equity.
Recent Chancery Decision Clarifies Basis for Judicial Dissolution of LLC
In In re Dissolution of T&S Hardwoods KD, 2023 Del. Ch. LEXIS 16 (Del. Ch. Jan. 20, 2023), the Delaware Court of Chancery clarified what kind of allegations seeking the dissolution of an LLC suffice to pass muster under the plaintiff-friendly Rule 12(b)(6) standard. The allegations reflected a "continuing breakdown" in the relationship of the managers. Moreover, despite the LLC agreement's broad, general purpose clause ("engage in any lawful activities"), the court determined the parties could not carry on their specifically contemplated business. Also, because the LLC agreement's buy-sell provision failed to offer the parties an equitable exit mechanism, the action proceeded past the motion to dismiss stage.
Caremark Claims Allowed to Proceed Against Corporate Officer
The Court of Chancery denied a motion to dismiss a McDonald's shareholders' derivative complaint against a company officer, which alleged that the officer breached his fiduciary duty of oversight. The officer contended that Caremark fiduciary obligations do not extend to Delaware corporate officers and thus did not apply to him. But the court disagreed. Mincing no words, the court in In re McDonald's Stockholder Derivative Litigation, 2023 Del. Ch. LEXIS 23 (Del. Ch. Jan. 25, 2023) wrote: "This decision clarifies that corporate officers owe a duty of oversight."
Who Can Represent a Cancelled LLC in Response to a Petition Seeking a Receiver?
In In Re Reinz Wisconsin Gasket, 2023 Del. Ch. LEXIS 194 (Del. Ch. May 8, 2023), after a company's counsel filed a notice of cancellation, the Court of Chancery prohibited a cancelled LLC from "participating in the process of appointing its own receiver or retaining counsel to do so." The petitioner sought to appoint a receiver and nullify the cancellation. Opposing the petitioner's requested relief, Delaware counsel entered appearances on behalf of the company. Though it granted the request, the court nevertheless invited the parties "to address the puzzle of a dissolved and cancelled entity appearing to litigate the propriety of its cancellation before they submitted proposed receivers."
The court reflected on the lifespan of an LLC, observing that an LLC's separate, statutory existence continues until the "cancellation" of its certificate of formation. Once an authorized person files a certificate of cancellation for the company, "its existence as a jural entity ceases." Upon the filing of the certificate of cancellation, "a defunct entity may speak only through a receiver to manage litigation or any other outstanding business: the receiver is appointed because there are no other fiduciaries to make decisions for the entity." Finding that a non-existent entity could not retain counsel, and considering it a "metaphysical wonder," the court determined: "Counsel's purported representation of a defunct limited liability company is not only puzzling, but impossible."
Delaware Court of Chancery Provides Guidance on Standard for Awarding Mootness Fees
In the runup to a merger, a shareholder plaintiff challenged the "don't ask, don't waive" provisions in the company's confidentiality agreements with the bidders by contending that the proxy statement contained materially deficient descriptions. In Anderson v. Magellan Health, 298 A.3d 734 (Del. Ch. July 6, 2023), following the suit's commencement, the company waived some of its confidentiality rights and supplemented its proxy statement, further detailing the "don't ask, don't waive" provisions.
The supplemental disclosures mooted the shareholder litigation. In the wake of the merger, shareholder plaintiff's counsel petitioned the Court of Chancery for a $1.1 million fee award. The company challenged the petition's "eye-popping" size.
Thoroughly reviewing the jurisprudential shift in M&A strike suits, the court opined that going forward, "unless a higher authority proclaims otherwise ... I will award mootness fees based on supplemental disclosures only when the information is material." Nevertheless, the court found it "unjust" to immediately apply that standard: Delaware courts had yet to apply it and neither the company nor the petitioner briefed it. Using only the "helpful" standard, the court found the supplemental proxy disclosures "marginally helpful" and, "putting it all together," awarded plaintiffs counsel a $75,000 fee.
Fee-Shifting in Section 220 Case Provides Cautionary Tale
In Seidman v. Blue Foundry Bancorp, 2023 Del. Ch. LEXIS 178 (Del. Ch. July 10, 2023), concerning a potentially excessive director and management equity incentive plan, a shareholder demanded to inspect the company's consulting reports and formal board materials in connection with the equity plan pursuant to DGCL Section 220. The shareholder asserted purposes of "investigating mismanagement and communicating with the fellow stockholders regarding any proxy contest or other corrective measures." Claiming the shareholder lacked a proper inspection purpose, the company rejected the demand and refused to produce a single document. The court had a much different view of the matter.
Emphasizing the exception to the American Rule under which the court may discretionarily shift fees "where equity requires," the court noted: "To capture the sorts of vexatious activities that the bad-faith exception is intended to address, this court employs the 'glaringly egregiousness' standard." Decrying "overly aggressive litigation strategies" in the books and records context and highlighting the company's less-than-scrupulous tactics, the court concluded: "After the company declined to produce a single document to the plaintiff, forcing him to commence litigation, the company took a series of litigation positions that, when viewed collectively, were glaringly egregious." Accordingly, "justice" required fee shifting to mitigate such "serious 'vexatious behavior.'"
Chancery Addresses Fiduciary Duty of Disclosure in Context of a Squeeze-Out
In Cygnus Opportunity Fund v. Washington Prime Group, 302 A.3d 430 (Del. Ch. Aug. 9, 2023), after an LLC controller and board of managers squeezed-out the minority unitholders, a group of hedge fund plaintiffs challenged certain disclosures in connection with the merger and a preceding tender offer. The Court of Chancery dove deep into Delaware's disclosure jurisprudence in the context of what the court referred to as the "stockholder-action duty."
Because Delaware law "piggybacks on the federal [securities] disclosure regime," the court entertained the notion that "if a controlling stockholder or third party makes a tender offer for the corporation's shares, then depending on the circumstances, the directors might well have a duty to respond. To the extent officers owe the same duties as directors, the duty could apply to them as well." Though the court could not "hash these issues out at the pleading stage," the plaintiffs stated a "conceivable" claim because the officers disclosed nothing in connection with "a severely underpriced" tender offer.
Moreover, examining the etymology of the word "fiduciary" and its trust law roots, the court emphasized that "the duty of disclosure is a context-specific duty, and no Delaware decision holds that fiduciaries do not owe any duty in the context of a transaction in which the fiduciaries unilaterally eliminate their investors from an enterprise." Because a squeeze-out is such a transaction, "the duty of loyalty could manifest as an obligation to inform the beneficiary of the material facts surrounding the transaction, regardless of whether or not the beneficiary's approval is required."
Part 2 of this client alert will include additional court decisions.
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.
