Over the past few months, Delaware courts have continued to address important M&A and corporate issues. Significant corporate law developments have also arisen from state and federal courts in California. Below are some highlights and practical takeaways related to important developments in Delaware law.
CORPORATE
Advance Notice Bylaws and Board Action Affecting the Stockholder Franchise.
Delaware courts are sensitive to the stockholder franchise but also appreciate the important role played by advance notice bylaws that often contain strict deadlines for submitting dissident slates for director elections. The Delaware Court of Chancery recently declined to require a corporation to waive its advance notice deadline to enable a board faction to nominate its own slate, finding that disregarding the deadline was not warranted based on certain board decisions, such as refusal to discipline the CEO, becausethat did not constitute a radical shift or material change that would substantially alter the direction of the company. In another case, the Delaware Supreme Court consolidated the Blasius compelling justification standard into Unocal enhanced scrutiny, explaining that when a board action interferes with the stockholder franchise, but does not have an inequitable purpose, the directors must show that their actions were reasonable in relation to their legitimate objective and did not coerce a particular vote (and thereby satisfy a closer fit between means and ends than in the traditional Unocal defensive measures context). The Court also affirmed that invalidity prescribed by Schnell for inequitable action would be appropriate where the board interfered with the stockholder franchise for selfish reasons or while lacking a good faith basis.1
Board Discretion Regarding Corporate Strategy, ESG Matters, and Decisions with Political Implications. The board has the authority and responsibility to manage all affairs of a Delaware corporation, including decisions relating to ESG issues and having political implications. The Delaware Court of Chancery recently rejected a stockholder’s demand for corporate books and records purportedly sought for the purpose of investigating potential wrongdoing by directors overseeing corporate response to Florida HB 1557, the “Parental Rights in Education” bill. The court found that the stockholder had not satisfied the relatively low bar for establishing a proper purpose required for such a demand.2
Contractual Exercise and Renegotiation by Corporate Fiduciaries. Corporate fiduciaries are permitted to exercise rights under contracts with the company but, if they act as directors or officers to cause the company to exercise discretion with respect to that contract, litigation claims challenging their conduct may be subject to judicial scrutiny. A recent fiduciary duty claim survived dismissal where a director and CFO may have triggered a company call right in a transaction potentially not contemplated by the contract, and then used their control over the company to cause it to renegotiate the contract, resulting in terms more favorable to the CFO.3
Officer Fiduciary Duties to Inform and to Obey the Board. Officers and directors owe the same fiduciary duties, but the contextual application of officers’ duties has been less explored by case law. The Court of Chancery recently addressed three disclosure obligations of officers in a tender offer and squeeze-out merger where LLC members had no approval right and were cashed out. First, the officers, who were found to have fiduciary duties under the terms of the LLC agreement, had an obligation to obey the board, which may include not making disclosures, unless obedience would be “so obviously wrong that compliance itself would constitute a breach of duty.” Second, the officers may have breached an obligation to inform the members of significant transactions that do not require member approval, such as unilaterally taking their equity interests. Third, the officers conceivably breached an obligation not to make misleading partial disclosures by giving disclosures about the squeeze-out merger, which omitted information concerning background, negotiations, pricing, company prospects, or board and independent committee rationales for their approvals.4
Dispute Resolution Authority of Arbitrators, Experts, and Directors.Contractual dispute resolution procedures may be less costly than litigation, but they are also subject to limits depending on the type of resolution proposed. In one recent case, the Delaware Court of Chancery confirmed that an arbitrator may have significant authority to make binding decisions, while an expert determination tends to be narrowly focused on matters within its expertise. In that case the “Accounting Firm” responsible for resolving earn-out disputes under a stock purchase agreement was viewed as an expert and not an arbitrator, based on the lack of words related to “arbitrating” and limits on the scope of a dispute resolution proceeding (e.g., 30 days for a decision). In two Delaware Supreme Court cases, the Court determined that a stock option agreement could grant a board committee “exclusive” authority to resolve disputes over interpretation of the agreement (including the scope of that committee’s authority), but a court was thereafter expected to conduct de novo review of the committee’s determinations, because (a) the committee was more akin to an expert than an arbitrator and (b) the provision required the committee to make legal determinations (not factual findings within its expertise). In another case, the Court held that a charter provision could not eliminate director liability or judicial review of board determinations of limits on stockholder voting power related to federal banking regulations.5
Waivers and Private Ordering Related to Fiduciary Duties. Fiduciary duties are a fundamental element of the internal affairs of corporations under Delaware law, as is the policy favoring private ordering, which includes waivers of core corporate rights under certain circumstances. The National Venture Capital Association Model Voting Agreement includes a covenant not to sue for breach of fiduciary duty in connection with a specified sale of the company. That covenant may be enforceable when narrowly tailored, reasonable under close judicial scrutiny, and not limiting of liability for intentional breaches of fiduciary duty. For instance, that standard may be satisfied by narrowly defining the terms of an applicable transaction and limiting application of the covenant to uber-sophisticated parties with counsel, negotiating power, adequate information, and awareness of the implications of the covenant. Such a covenant would face deep judicial skepticism in other scenarios, such as in a stock letter of transmittal, an agreement binding a retail stockholder, or an employee stock grant or compensation plan.
MERGERS & ACQUISITIONS
Transactions with Significant Stockholders. Judicial scrutiny of breach of
fiduciary duty claims challenging transactions
with significant stockholders has continued with
guidance regarding the court’s view of advisable
and inadvisable processes. Although exclusion of
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one such stockholder, who was conceivably a
controller on a motion to dismiss, was
inadequate to obtain early dismissal, the court
found after trial that the stockholder was not a
controller and the transaction was not unfair,
based in part on the independence of a
committee that negotiated vigorously for the
best deal. Another such transaction was also
found after trial to be fair, based on the
initiation, timing, structure, negotiation, and
approval of the transaction. And in three other
such transactions, the court explained that postclosing management agreements would be
examined more closely when they provided
material benefits instead of continuing preexisting arrangements; that alleged failure to
conduct a market check, selection of potentially
conflicted advisors, and low valuation of
litigation claims did not indicate a lack of care
necessary to undermine a MFW process; and
that the “ab initio” requirement was satisfied
when the MFW dual conditionality was imposed
before conflicts arose with respect to economic
bargaining related to the controller’s postclosing employment.
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Buyer Aiding & Abetting Liability. The
Delaware Court of Chancery has recently
explored the typically remote possibility of buyer
liability for aiding and abetting a breach of
fiduciary duty, finding facts to support such a
claim in two cases. The court explained in one
case that the relevant sale process had three
phases: (1) bidding by the buyer and other
bidders when sell-side management was found
to be motivated for a quick sale and
communicated that desire to the buyer, (2)
persistent unsolicited efforts to acquire the
target including breaches of standstill provisions
(e.g., don’t ask, don’t waive) when management
seemed to acquiesce after the target board
terminated the process, and (3) between signing
and closing when the deal documents contained
provisions for buyer sign-off on disclosures to
seller stockholders and the buyer would have
known that its earlier activities were not fully
disclosed. Delaware courts will harshly view
buyers who obtain privileged access to disloyal
sell-side factors and use that relationship to
ignore guardrails or violate boundaries
established by the sell-side board in a persistent
and opportunistic manner. In another case, an
aiding and abetting claim survived where the
buyer was involved in restructuring a
transaction to channel consideration away from
a specific sell-side investor that the other sellers
were seeking to exclude from the deal.
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Waiver of Post-Closing Indemnification
Rights. Recent cases have addressed the
effectiveness of waivers by pre-closing target
company officers of their indemnification rights
under pre-closing contracts and governing
documents. The pre-closing officers in one case,
who were knowledge parties but not signatories
to the relevant merger agreement that provided
for continuation of indemnification under preclosing bylaws but eliminated indemnification
with respect to any breach of the merger
agreement, executed resignation letters
containing releases. The releases and
elimination of indemnification rights under the
pre-closing bylaws were not enforced against the
officers, because the release was not clear and
unequivocal, especially as to an officer who had
not been permitted to see the merger agreement.
In another case, however, the former officer did
not have indemnification rights under the preclosing company’s agreements and bylaws, after
the officer sold his shares under a stock
repurchase agreement that contained a broad
release of all claims against the company other
than certain claims arising under that
repurchase agreement.8
Stockholder Approval of Merger
Agreement and Substantial Asset Sale.
The Delaware General Corporation Law (DGCL)
sections related to mergers contemplate steps to
be taken in a particular sequence. The Delaware
Court of Chancery recently emphasized that the
signed merger agreement attached to non-stock
member or stockholder consents must be dated
and not have blank placeholders. The court also
explained that wrongful coercion, such as
threatening to seize assets or terminate the
entity, can taint the approval of a merger
agreement. The period for demanding appraisal
rights also will not begin, with respect to a
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merger approved by stockholder consent, until
the stockholders have approved the merger
agreement and notice of that consent has been
given. In the separate context of a sale of
substantially all assets, Delaware case law
provides a range of considerations for
determining whether the sold assets represent
substantially all assets on quantitative and
qualitative bases. A recent decision determined
that a sale of approximately 37-38% of the
company’s total assets and 57-62% of the
company’s revenue, which sale required the
company to alter operations but did not affect its
existence or purpose, did not constitute a sale of
substantially all assets. As a result, the sale did
not violate Section 271 or the board’s fiduciary
duties for failure to obtain a stockholder vote.9
Fiduciary Duties in Insolvency and
Distressed Transactions. The Delaware
Court of Chancery recently confirmed that, when
a corporation is insolvent, creditors become
residual claimants that have standing to bring
fiduciary duty claims. The court found that the
directors and officers may have approved a
foreclosure arrangement based on their belief
that fiduciary duties had shifted from
stockholders to creditors. The court rejected this
view of fiduciary duties, as well as a perceived
improper focus on advancing the interests of
employees, stating that fiduciary duties in
insolvency do not shift away from the
corporation and its stockholders. In another case
involving the related context of distressed
financings, the court noted the troubling aspects
of such transactions involving exclusion of
directors from board meetings, actions of a
secretly formed restructuring committee to
structure a dilutive financing for a company that
may been down to its final months’ of cash
remaining, payment of legal fees for parent
holding companies’ employees, and inadequate
disclosure to minority stockholders expected to
waive related claims with 15 days to consider
participation. The court also noted concerns
about another equity transaction where the
board (controlled by certain investors) may have
restructured the transaction for almost all of the
deal consideration to flow directly or indirectly
to all but one of the company’s investors,
including to their affiliates that were creditors of
the company, and the sellers agreed to
indemnify the buyer from claims by the excluded
investor. There, the court also noted that debt
held by insiders can be equitably subordinated,
diminishing its value, which could be relevant
for purposes of determining consideration owed
to the creditor and the solvency of the
company.10
Effect of Disinterested Stockholder
Approval on Claims for Injunctive Relief
against Defensive Measures. The Corwin
line of Delaware case law provides that fully
informed, uncoerced approval by disinterested
stockholders may cleanse claims for breach of
fiduciary duty not involving a conflicted
controlling stockholder. The Delaware Court of
Chancery recently explained, however, that such
cleansing does not apply to foreclose actions for
injunctive relief. In the recent case, the court
rejected Corwin cleansing as to alleged defensive
measures adopted by the board of a public
company whose diminished stock price made it
an attractive takeover target. Those measures
implicated Unocal entrenchment concerns in
connection with a sale of shares that could have
been important in director elections (those
shares were (i) required to vote for the board’s
director nominees, (ii) required to vote either
according to the board’s recommendation as to
non-routine matters or pro rata with other
stockholders, and (iii) subject to transfer
restrictions requiring board approval and
preventing transfer to competitors or certain
activist investors).
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Specific Performance Denied in Busted
International Deal. After several busted deal
cases in recent years where the Delaware Court
of Chancery awarded specific performance, the
court recently confirmed that such an award is
in its discretion and remains subject to many
factors including the practicability of
international enforcement. This busted de-SPAC
deal involved a Philippine corporation with a
history of internal corporate governance issues
and parallel legal proceedings in Philippine
courts. The Delaware Court of Chancery denied
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specific performance and identified numerous
challenges to enforcement of a specific
performance award, including complications
with respect to the SEC process for issuing
securities of that Philippine corporation, “dodgy”
bargains to secure political intervention, limits
on the court’s coercive powers outside of the
United States, and conflicting international
judicial decisions. Although this case involved
unusual facts, international deal planners should
bear this in mind with respect to typical merger
agreement provisions such as those for
remedies, dispute resolution, and related
matters.
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RELATED TOPICS AND OUTLOOK
Mid-Year Trends Related to Delaware
Corporate and M&A Law. Several notable
trends related to Delaware corporate law have
emerged in 2023, including increasing proposal
and adoption of amendments to public company
charters providing for exculpation of officer
liability under Section 102(b)(7) as amended in
2022.13 We have also seen directors, officers, and
investors of private companies navigating issues
regarding fiduciary duties and DGCL provisions
applicable to distressed financings and potential
insolvency, including dilution of current
investors and inclusion of pay-to-play and pullup financings designed to terminate existing
liquidation preferences and other investor
rights. The complexities of distressed financings
and M&A transactions may add complexity to
board discussions and disinterested director and
stockholder approval requirements contained in
stockholders’ agreements.
Forum Selection Provisions Regarding
Exchange Act Claims and Claims by
California-Based Litigants. Forum selection
provisions are expressly permitted under
Delaware law and generally enforceable, though
questions have arisen whether the Securities
Exchange Act of 1934 prohibits such provisions
from requiring that derivative claims under the
Exchange Act be brought in state court and
whether the California constitution prohibits
enforcement of such provisions as to claims by
California-based litigants who are entitled to
civil jury trials. Although the 9th Circuit stated
that state courts would lack jurisdiction to hear
those Exchange Act claims, the circuit rejected
arguments that forum selection provisions were
unenforceable with respect to those claims. The
circuit noted that stockholders could bring those
claims directly in federal court and that Section
115 of the DGCL permits such provisions. This
decision also maintains a split with the 7th
Circuit, which may lead to resolution of the issue
by the US Supreme Court.14 The California
Fourth Appellate District recently held that,
because the Court of Chancery effectively does
not offer jury trials, enforcement of a facially
valid charter and bylaw provisions selecting the
Court of Chancery as the exclusive forum would
operate as an impermissible implied waiver of
the right to a jury trial, which is nonwaivable
under the California constitution before
commencement of a dispute. The state appeals
court affirmed denial of a motion to dismiss,
based on the forum selection provision, claims
brought in California state court against the
Delaware corporation’s officers, employees, and
largest stockholder and third parties for
fraudulent concealment, promissory fraud,
breach of contract, breach of fiduciary duty, and
violations of California’s Unfair Competition
Law, as to which the California-based plaintiffstockholder demanded a jury trial on all claims
to which the right to a jury trial attached.
15
Counsel should keep this in mind when drafting
forum selection provisions.
2023 Amendments to Delaware Entity
Statutes. Delaware has adopted several
important amendments to the DGCL, which are
discussed in a separate GT Update, but we
highlight a few here. The amendments have
reduced or eliminated the stockholder approval
standard for certain forward and reverse stock
splits and changes in the number of authorized
shares under Section 242. Following litigation
over a disputed transaction related to
foreclosure, significant updates to Section 272
permit certain sales, leases, or exchanges of
collateral assets securing a mortgage or pledge
without stockholder approval under Section 271.
The stockholder approval standard has also been
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reduced to a majority of the outstanding voting
power for Delaware corporations to domesticate
as non-US entities under Section 390, and that
provides additional flexibility for Delaware
corporations desiring to domesticate outside of
the United States while potentially continuing
their existence as a Delaware corporation.
Amendments to Delaware’s LP Act, LLC Act, and
GP Act permit a subscription agreement to
provide for its irrevocability, which can be
important in equity financings with closings over
an extended period.
16
National Venture Capital Association
Updates Its Model Amended and Restated
Certificate of Incorporation. The NVCA’s
model charter, which provides form language for
many venture capital-backed corporations, has
been updated. Some changes account for
developments in Delaware law since the prior
version, such as clarification of the designation
of classes and series of stock and the
incorporation of statutory conversions and
domestications into the deemed liquidation and
protective provisions. Other changes reflect
alternative options and provisions that are
sometimes negotiated in venture capital
financing transactions. We anticipate that these
updated model provisions will begin finding
their way into preferred-stock financings and
governing documents. Care should be given
when considering which updated language to
include in transactions going forward, as is
always true when considering open-source
forms.17
