Section 220 Demands and Confidentiality Agreements

In Tiger v. Boast Apparel, Inc., No. 23, 2019 (Del. Supr. Aug. 7, 2019), the Delaware Supreme Court addressed Section 220 demands and the prevailing corporate practice of requiring confidentiality agreements before a stockholder is entitled to its books and records.

The opinion resulted in two important holdings:

(1) Although Section 220 inspections are typically subject to a confidentiality order, such inspections are not subject to a presumption of confidentiality; and

(2) When the court, in its discretion, enters a confidentiality order, an indefinite period of confidentiality protection is not dependent on a showing of the absence of exigent circumstances by the stockholder.

In the case at bar, an initial Section 220 demand was made in December 2014.  The primary dispute related to the scope and duration of a confidentiality agreement that the company required.  A second Section 220 demand was made in February of 2017, but yet again the parties could not reach agreement over the terms of a confidentiality agreement.  In October 2017, a complaint was filed in the Court of Chancery demanding access to books and records based on an amended demand made in May 2017.  The scope of the confidentiality obligations imposed by the company on its production remained the primary dispute.

A Master in Chancery submitted a report in July 2018 recommending indefinite confidentiality until such time as the stockholder filed a suit based on the inspection, after which confidentiality would be controlled by the applicable court rules. This appeal followed the finality of the Master’s Report.

Although the Supreme Court disagreed with the Court of Chancery’s reasoning, it affirmed the decision because there was no abuse of discretion or reversible error with the result.  The Supreme Court clarified that there is no presumption of confidentiality in Section 220 productions. Instead, the Court of Chancery must assess and compare benefits and harms when determining the initial degree and duration of the confidentiality order.  In crafting the degree and duration of a confidentiality order, the burden on the corporation is more demanding and the burden on the shareholder is less demanding because there is no presumption of confidentiality in Section 220 productions.

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Delaware Superior Court Weighs in on Contract Ambiguity

In V&M Aerospace, LLC v. V&M Co., the Superior Court engaged in contract interpretation to resolve a dispute arising out of an Asset Purchase Agreement (APA) entered into in 2015 by V&M Aerospace LLC (Aerospace) and V&M Company (VMC) for the sale of substantially all of the assets of VMC’s chrome plating business.

Aware that the land the facility was environmentally situated on was contaminated, the parties expressly provided within the term of the APA that VMC would indemnify Aerospace and would be held responsible for any environmental losses occurring prior to the APA’s closing date. Similarly, Aerospace would be held responsible for environmental losses occurring on or after the APA’s closing date and have an obligation to indemnify VMC in actions arising from that harm. An environmental claim was filed in California in 2017 against VMC, who then filed a cross-complaint against Aerospace seeking indemnification under the belief the harm occurred after the APA’s closing date.

Subsequently, Aerospace notified VMC that it would be offsetting any attorneys’ fees incurred against its next quarterly payment to VMC. Aerospace claimed that it was entitled to do so under the APA, which granted it the right to offset any claim for a loss against payments owed to VMC. The question presented before the court was whether Aerospace was justified in exercising its offset rights given that it is allegedly responsible for the harm underlying the California litigation.

The court resolved this dispute by interpreting Section 17 of the APA, the portion granting Aerospace offset rights. The first sentence of Section 17 provided Aerospace offset rights for losses related to non-environmental claims and the second sentence provided offset rights for losses related to environmental claims. The court concluded that the inclusion of the limiting phrase “subject to indemnification” within the first sentence and the phrase’s exclusion in the second sentence demonstrated an intended distinction between the scope of the two offset rights. Further, the court held that based on the clear and unambiguous language of the APA and strong policy of freedom of contract, Aerospace may offset losses related to environmental claims regardless of whether those losses are “subject to indemnification”.

In response to VMC’s arguments that this result would unjustly punish it for exercising indemnification obligations, the court countered that regardless of whether the offset was due to loss from an environmental or non-environmental claim, Aerospace would be permitted to exercise this right before indemnification obligations were resolved. Moreover, the court dismissed VMC’s objections that the interpretation was fundamentally unfair by assuring VMC that if the indemnification obligations were resolved in its favor, it would be able to recoup all improperly offset amounts as contemplated by the language of Section 17, which discussed offsets that are later determined to be improper by the court or arbitrator.

Read the full opinion here.

Kaitlin McCaffrey & Chris Lee

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Deposition Practice – Lawyer Admonished for Failing to Control “Ridiculous” Deponent

The Supreme Court recently heard consolidated appeals in the matter of In Re: Shorenstein Hays-Nederlander Theatres LLC Appeals; however, the issues appealed were of secondary importance to the deponent’s deposition misconduct.  In the Addendum to its Opinion, the Court quoted and addressed the deposition conduct of Carole Shorenstein Hays, a co-fifty percent owner of Shorenstein Hays-Nederlander Theatres LLC, one of the entities subject to litigation, and her counsel’s silence under its “exclusive supervisory responsibility to regulate and enforce appropriate conduct of … all lawyers, litigants, witnesses, and others’ participating in a Delaware proceeding.”

Ms. Hays deposition conduct was, as the Court put it, “ridiculous [and] … flippant.”  The following excerpt serves as a representative but incomplete picture of Ms. Hays conduct:

  • Q. When was SHN founded?
  • A. At the beginning.
  • Q. In what year?
  • A. The year it was founded.
  • Q. Can you give me a year?
  • A. No.
  • Q. Who founded it?
  • A. I was there.
  • Q. What do you mean when you say you were there?
  • A. I was there at the very beginning when it was – at the very day one.
  • Q. Does that make you a founder?
  • A. Does giving birth to a child make you a mother?
  • Q. Yes, but that wasn’t my question. My question was, the fact that you were there, does that make you a founder?
  • A. I believe it’s semantics.

Ms. Hays’ pro hac counsel at no time attempted to “rein in” his client and allowed the absurd responses to continue. The Court noted that counsel has “a responsibility to intercede and not sit idly by as their client engages in abusive deposition misconduct … [a]n attorney representing a client who engages in such behavior during the course of a deposition cannot simply be a spectator and do nothing.”

Delaware attorneys should be forewarned that they have an obligation to ensure that their out-of-state counsel follows Delaware customs and procedures during all the stages of litigation – including controlling a flippant client.

Read the full opinion here (the Addendum starts on page 51).

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Delaware Court Revives Blue Bell Creameries Shareholder Suit

In the case of Marchand v. Barnhill et al., No. 533, 2018 (Del. June 19, 2019), the Delaware Supreme Court reversed the dismissal of a stockholder derivative lawsuit against the members of the board of directors and two officers of Blue Bell Creameries USA, Inc., a leading manufacturer of ice cream products. 

The lawsuit arose out of a listeria food contamination incident in 2015 that resulted in widespread product recalls and was linked to three deaths.  The Plaintiff alleged that Defendants breached their duties of care and loyalty by knowingly disregarding contamination risks and failing to oversee the safety of Blue Bell’s food-making operations, and that the directors breached their duty of loyalty under Caremark

Defendants moved to dismiss in the Court below for failure to plead demand futility.  That motion was granted.  The Caremark claim was also dismissed because the Court of Chancery found that Plaintiff only pleaded that an inadequate monitoring system was in place rather than a complete failure to implement an oversight system – the necessary allegations to maintain a Caremark claim. 

On appeal, the Supreme Court reversed and remanded as to both holdings.  First, the Court held that Plaintiff adequately raised a reasonable doubt that a majority of Blue Bell’s directors could have impartially considered a pre-suit demand. In the Court below, Plaintiff fell one director short of showing that a majority of the members of the board were interested.  The Supreme Court reversed as to one director, Rankin, because they found he owed his successes to the Kruse family, the founders of Blue Bell. Additionally, the Kruses spearheaded charitable efforts that led to a $450,000 donation to a key local college, resulting in Rankin being honored by having Blinn College’s new agricultural facility named after him.

The Court also found that Plaintiff pleaded adequate facts to support the reasonable inference “that no board-level system of monitoring or reporting on food safety existed.”  Even after various regulatory agencies and internal employees reported issues with the cleanliness of Blue Bell facilities, the issues were not brought up during any board meetings.  The Court also concluded that “food safety was essential and mission critical” to Blue Bell’s business.  Because of this, the Supreme Court ruled that bad faith was adequately pleaded and reversed and remanded for proceedings consistent with the opinion.

Read the full opinion here.

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An “Efficient Breach” Does Not Absolve One from Contractually Agreed Upon Damages

In the recent case of Leaf Invenergy Co. v. Invenergy Renewables LLC, No. 308, 2018 (Del. May 2, 2019), the Delaware Supreme Court reversed the Court of Chancery’s nominal damages award under the “efficient breach” theory.  The Supreme Court confirmed that an efficient breach is not a bar to recovery or a device for modifying damages calculations.  Instead, an efficient breach occurs when a party finds an intentional breach’s benefits outweigh the damages it might owe. 

Plaintiff Leaf Invenergy Company invested $30 million in Invenergy Wind LLC.  Leaf negotiated a consent provision in the LLC Agreement that prohibited Invenergy from conducting a Material Partial Sale without Leaf’s consent, unless Invenergy paid Leaf a premium call the Target Multiple.  Several years after the investment, Invenergy closed a $1.8 billion asset sale (a Material Partial Sale) without first obtaining Leaf’s consent or redeeming Leaf’s interest at the Target Multiple.  Leaf then initiated suit for breach of the LLC Agreement.

The Court of Chancery found that Invenergy breached the Consent Provision, but Leaf was not entitled to the Target Multiple.  Applying the “efficient breach” theory, the Court of Chancery posited a hypothetical negotiation exercise where Leaf was required to show that it would have secured additional consideration if given the opportunity to negotiate for its consent, or that it suffered harm because of the asset sale.  Additionally, the Court of Chancery found, Invenergy likely would not have closed on the asset sale if it had to pay the Target Multiple. Only nominal damages were therefore appropriate.   Ultimately, the Court of Chancery ordered the parties to complete a buyout of Leaf’s interests pursuant to a put-call provision in the operative agreement, which Invenergy exercised during the suit. 

On appeal, the Supreme Court reversed, explaining that the Consent Provision was an either-or structure requiring Leaf’s consent or payment. The Court of Chancery’s analysis only considered Invenergy’s breach of the consent portion of the clause at issue, and not its breach of the payment portion of the clause. The Court of Chancery should have considered the full effect of Invenergy’s contractual breach when it failed to seek Leaf’s consent and then failed to pay the Target Multiple, rather than focusing on the harm to Leaf.

The Supreme Court also explained the trial court’s misapplication of the efficient breach theory.  The concept of efficient breach applies where it is economically advantageous for a party to breach a contract because the breach’s benefits outweigh the damages it will be required to pay to the non-breaching party. The concept does not justify modifying the amount of contractually agreed upon damages.  Instead, such damages must be calculated based on the degree of injury suffered.  Since Leaf did not give its consent, the appropriate expectation damages were the Target Multiple.  Accordingly, the Supreme Court reversed the nominal damages award, substituting an award of the Target Multiple, $126,000,000, conditional on Leaf’s surrender of its membership interests.

Read the full opinion here.

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Delaware Court of Chancery Weighs-In on CFAA

In AlixPartners, LLP and AlixPartners Holdings, LLP v. David Benichou, C.A. No. 2018-0600-KSJM, the Court of Chancery was tasked with interpreting the Computer Fraud and Abuse Act (CFAA) absent direct federal authority on the issue.

Image result for computer fraud and abuse act

Federal courts are divided on the proper interpretation between a broad approach and a narrow approach. The relevant section of the CFAA renders a person liable who “intentionally accesses a computer without authorization, or exceeds authorized access, and thereby obtains…information from any protected computer.”[1] The crux of the disagreement centers on the interpretation of the terms “without authorization” and “exceeds authorized access”.

The First, Fifth, Seventh, and Eleventh Circuits have adopted a broad approach which establishes liability where an employee’s use violates an obligation related to computer access. While these Circuits agree on the correct approach, the rationales diverge. The First Circuit held that an employee was exceeding his or her authorized access if that use was in violation of an access-related agreement. In contrast, the Seventh Circuit reasoned that an employee using information in a manner adverse to his employer is violating his loyalty duties, thereby effectively terminating the agency relationship and removing authority to access the information.

 The narrow approach adopted by the Second, Fourth, and Ninth Circuits interprets these provisions to establish liability only where there is unauthorized access of protected computers. The lead rationale for this interpretation is the potentially “far-reaching effects” conceivable under the broad approach, such as imposing liability on an employee who violates company policy by downloading information from her work computer to work at home.

In AlixPartners, the Court of Chancery chose to adopt the narrow approach. This decision was made in consideration of the plain language of the statute, its legislative intent, and the rule of lenity. The Court’s interpretation would impose liability only when an individual accesses a computer or information on that computer without permission. This interpretation would not impose liability for misuse of information to which the individual had authorized access. 

The case at hand that advanced this question involves a former partner of AlixPartners, David Benichou, who allegedly transferred documents from his work computer to a personal external hard drive on two separate occasions. The first instance alleged occurred prior to Benichou’s dismissal from AlixPartners and the second instance after. Applying the newly adopted approach, the Court of Chancery held that the data transfer while Benichou was still employed with AlixPartners did not support a claim under the CFAA as he had authorized access at the time. However, Benichou’s authorization was terminated upon his dismissal and therefore AlixPartners was able to assert a claim under the CFAA for the later data transfer.

Read the full opinion here.

Kaitlin McCaffrey

[1] 18 U.S.C. § 1030(a)(2)(C)

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Court of Chancery Rule 15(aaa) Expanded…With a Twist

It has long been the case that when a Defendant in a Delaware Court of Chancery matter files a motion to dismiss pursuant to rules 12(b)(6) or 23.1, the plaintiff has one of two choices: 1) amend her complaint instead of oppose the motion, or 2) defend against the motion and risk dismissal with prejudice.

In Otto Candies, LLC v. KPMG, LLP et al., plaintiff initially brought suit in the Superior Court, which upon defendants’ fully briefed and argued motions to dismiss, determined it did not have subject matter jurisdiction. Plaintiff transferred the matter to the Court of Chancery, along with the pending motions to dismiss. Thereafter, the Court dismissed Plaintiff’s claim for lack of personal jurisdiction and failure to state a claim, however, the Court requested additional briefing on whether its dismissal should be with prejudice or without prejudice.

The parties provided supplemental briefing and the Court held that Court of Chancery rule 15(aaa) did indeed apply to transferred cases. However, the Court determined that because this was the first time the Court of Chancery had been faced with this issue, the plaintiff deserved a “mulligan.” As a result, the Court dismissed the matter without prejudice under the “good cause” exception…just this one time.

Read the opinion here.

Chris Lee

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Rent-A-Center not bound by merger deal with Vintage Capital

In the case of Vintage Rodeo Parent, LLC et al., v. Rent-A-Center, Inc., the Court of Chancery announced that Rent-A-Center was within its rights to back out of a $1.36 billion merger deal with private equity firm Vintage Capital Management (collectively with all Vintage entities “Vintage”) last year as a result of Vintage failing to inform Rent-A-Center that it was extending the merger deal by an agreed-upon date (“End Date”).

Vintage agreed to acquire Rent-A-Center last June. Since both parties own rent-to-own retail stores, the merge required antitrust clearance from the U.S. Federal Trade Commission that could take considerable time to accomplish. Vintage Capital’s banker, B. Riley Financial Inc., also guaranteed a $126.5 million reverse termination fee.

Vintage and Rent-A-Center agreed that if the deal was not approved by December 17, 2018, either party could give notice that it was unilaterally extending the contract for an additional 90 days. However, if neither side gave that notice, the contract stated that either party could terminate the deal at will by giving notice. Rent-A-Center terminated the deal on December 18, after receiving no notice from Vintage.

Vintage argued that the parties actions leading up to the End Date showed an intent to close after the End Date and because of those actions, Vintage either adequately gave notice or the extension notice provision had lost its relevance (and enforceability) in light of both parties’ intent to proceed past the End Date, or Rent-A-Center’s actions showed that it waived the notice of election to extend. Alternatively, Vintage argued that Rent-A-Center acted fraudulently by appearing as though it intended to go through with the merger when it did not so intend.

The Vice Chancellor found that these actions were merely consistent with the parties’ mutual obligations to use commercially reasonable efforts to effectuate the closing. The Court ruled that Vintage had offered no explanation for not giving notice, leading to the “startling conclusion” that “certain Vintage and B. Riley personnel, in the context of this $1 billion-plus merger, simply forgot” to give it. The Court sympathized with Vintage, noting it was “understandable” that Vintage and B. Riley were angered at what they perceived as a sharp practice by Rent-A-Center, but that the clear language of the contract allowed Rent-A-Center to take the action it did.

The Court requested further briefing on the reverse termination fee as it was considerably higher than similar fees, which are generally in the range of 3% of the total merger consideration.

Read the full opinion here.

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Court of Chancery Addresses Method for Perfecting Service on a Defunct LLC

In the case of Tratado de Libre Commercio, LLC v. Splitcast Technology, LLC, C.A. No. 2019-0014-JRS, the Court of Chancery was called on to determine the proper method to perfect service on a dissolved LLC that completed the winding up process.

In the Complaint, Plaintiffs sought to: (a) nullify the certificate of cancellation of Splitcast; (b) return assets to Splitcast so that the assets can be used to satisfy Plaintiffs’ claim against Splitcast; and (c) appoint a member of Splitcast to serve as trustee to defend Plaintiffs’ claims against it.

Splitcast asserted that it was properly dissolved in October 2015 and could not be served with process through traditional means.  The Court agreed.   The Court, however, directed that service may be perfected upon Splitcast by publication and certified mail pursuant to Court of Chancery Rule 4(d)(7).

Finding no direct authority on point regarding the proper method to perfect service on a defunct LLC, the Court looked to general corporation law.  Previously, the Court found that pursuant to Chancery Rule 4(d)(7) and 8 Del. C. § 279 service could be perfected on a defunct corporation.  The Court found that like 8 Del. C. § 279 in the corporation context, 6 Del. C. § 18-805 allows service on a dissolved LLC.

In Krafft, the Court found that Chancery Rule 4(d)(7) and Section 279 authorized service on a dissolved corporation that was a necessary party to litigation even though the three-year statutory winding up period expired. The court ordered that, to perfect service, the petitioners were required to publish notice in newspapers published in Delaware and Virginia, the locations of the residences of the dissolved entity’s former officers, and to provide additional written notice to an attorney associated with the corporation.

Drawing on the authority in Krafft , the Court indicated that Plaintiffs could perfect service on Splitcast by: (1) publishing notice in a widely-circulated Delaware newspaper daily for two consecutive weeks; (2) mail copies of the summons, verified complaint, and the Court’s opinion on perfecting service to the former senior officers of Splitcast at their last known addresses and separately to the officers counsel; and (3) file an affidavit of compliance with the Court outlining the steps Petitioners took to comply with the Court’s directions.

The Court also addressed the proper procedure for appointing a trustee to defend the claims against Splitcast.  At the outset, the Court noted that it could not consider the petition to appoint a trustee until service was perfected on Splitcast. After service is perfected, the Court referred the parties to Chancery Rule 150 which prohibits a nonresident from serving as the sole receiver for an alternative entity.  Pursuant to Rule 150, if all the former senior officers of Splitcast are non-Delaware residents, the Court directed Plaintiffs to propose a member of the Delaware bar to serve as co-trustee or explain why Rule 150 should be waived.

Read the Court’s full opinion here.

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Superior Court Applies “Dual” Personal Jurisdiction

The requirements necessary for establishing personal jurisdiction in the United States have grown increasingly difficult in recent years due to SCOTUS opinions such as Bristol-Myers Squibb, Daimler, and Goodyear. Various approaches to establishing personal jurisdiction, such as California’s sliding-scale approach, have been rejected by the SCOTUS.  Delaware’s “dual” personal jurisdiction has not been expressly rejected and was followed by the Delaware Superior Court in the recent case of Cardona v. Hitachi et al.

In the present case, Cardona, a Maryland resident, sued the designer and manufacturer of a nail gun, HKK a Japanese Corporation, along with its wholly-owned US subsidiary and distributing entity, HKU, alleging that the nail gun malfunctioned and caused Cardona serious permanent injuries while at a job site in Delaware.  HKK moved to dismiss as Cardona failed to establish specific personal jurisdiction.

In determining if the court holds personal jurisdiction over a party, the Superior Court recited the two-step approach. First, the court must look to Delaware’s long-arm statute and determine whether jurisdiction is appropriate there.  Second, the court must assure that jurisdiction complies with the Due Process Clause of the US Constitution.

Delaware’s long-arm statute affords the court jurisdiction to the maximum extent allowed by the US Constitution and contains both specific and general personal jurisdiction provisions. A combination of the two, “dual” jurisdiction has developed:

It is conceivable that a tort claim could enjoy a dual jurisdiction basis under (c)(1) [general] and (c)(4) [specific] if the indicia of activity set forth under (c)(4) were sufficiently extensive to reach the transactional level of (c)(1) and there was a nexus between the tort claim and transaction of business or performance of work.

Further clarified, “dual” jurisdiction exists as long as “(1) the defendant manufacturer demonstrates ‘an intent or purpose to serve the Delaware market with its product,’ and (2) that intent or purpose results in the introduction of the product into Delaware and ultimately causes the plaintiff’s injury.”  The Court did note that there have been criticisms to the “dual” jurisdiction approach.

The Court, sub judice, found that an intent to serve the Delaware market was shown by HKK setting up HKU a Delaware entity responsible for distributing HKK’s products to the US.  Also, although the specific nail gun’s point of origin is unknown, the specific model of nail gun is sold at Lowe’s stores nationwide and a strong inference exists that “significant amounts of [nail guns] have been sold in … Delaware.”

The Court went on to conduct a Due Process analysis, holding that, “HKK … solicited business from the whole U.S. market, and … HKK’s products were sold in Delaware.” Additionally, nail gun sales in Delaware were part of the “regular and anticipated flow” of commerce, not a fortuitous event – HKK set up a Delaware subsidiary for exactly this purpose.  The Defendant argued that Bristol-Meyers Squibb overruled the “stream of commerce” theory, but the Court disagreed. What was missing in Bristol-Meyers Squibb was a connection between the forum state and the claim.  Here, Plaintiff was performing a job in Delaware and the nail gun was supplied by a Delaware employer (also a named defendant). The Court found that the above actions satisfied at least two of the tests outlined in Asahi and denied the Defendant’s Motion to Dismiss.

Read the full opinion here.

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