Rebecca L. Butcher
Landis Rath & Cobb LLP
919 N. Market St.
Wilmington, DE 19801
Morris James LLP
500 Delaware Ave.
Wilmington, DE 19801
Samuel E. Bashman
Morris James LLP
500 Delaware Ave.
Wilmington, DE 19801
Albert J. Carroll
Morris James LLP
500 Delaware Ave.
Wilmington, DE 19801
Clarkson Collins, Jr.
500 Delaware Ave.
Wilmington, DE 19801
Damon B. Ferrara
500 Delaware Ave.
Wilmington, DE 19801
500 Delaware Ave.
Wilmington, DE 19801
Lewis H. Lazarus
500 Delaware Ave.
Wilmington, DE 19801
Matthew F. Lintner
500 Delaware Ave.
Wilmington, DE 19801
Albert H. Manwaring, IV
500 Delaware Ave.
Wilmington, DE 19801
Ian D. McCauley
500 Delaware Ave.
Wilmington, DE 19801
Kathleen A. Murphy
500 Delaware Ave.
Wilmington, DE 19801
500 Delaware Ave.
Wilmington, DE 19801
Benjamin M. Potts
Wilson Sonsini Goodrich & Rosati LLP
222 Delaware Ave.
Wilmington, DE 19801
Jonathan G. Strauss
500 Delaware Ave.
Wilmington, DE 19801
500 Delaware Ave.
Wilmington, DE 19801
Patricia A. Winston
500 Delaware Ave.
Wilmington, DE 19801
Kirsten A. Zeberkiewicz
500 Delaware Ave.
Wilmington, DE 19801
§ 1.1 Introduction
The year 2020 saw numerous significant corporate law decisions from the Delaware courts. Stockholders’ requests for non-public information under Section 220 of the Delaware General Corporation Law continued to be litigated, with both the Delaware Supreme Court and Court of Chancery issuing decisions clarifying the stockholder’s relatively low burden of proof in this area. See § 15.2, infra. The Delaware courts also issued important corporate governance decisions addressing disclosure obligations among fellow directors, conflicting decisions of board committees, and the permissible extent of forum selection provisions in the organizational documents of Delaware corporations. See §15.3, infra. In the M&A context, the issues of whether a transaction involves a controlling stockholder or control group continued to be a subject of significant litigation, including whether adequate procedural protections were employed to permit deferential review of controlling stockholder transactions under the business judgment rule. The Delaware Court of Chancery also considered whether the current COVID-19 circumstances give rise to a “material adverse effect” within the intendment of an acquisition agreement. See § 15.4, infra. Appraisal litigation in the public company context continued to address deference to market indicators, with notable rulings including a decision affirming reliance upon a corporation’s unaffected trading price. See § 15.5, infra. On the regulatory front, Nasdaq recently proposed to the U.S. Securities and Exchange Commission new requirements mandating disclosures concerning corporate boards’ inclusion and diversity policies and practices. See § 15.8, infra. These developments, as well as demand futility decisions (§ 15.6) and advancement decisions (§ 15.7) are discussed herein.
§ 1.2 Books and Records
AmerisourceBergen Corp. v. Lebanon Cty. Employees’ Ret. Fund, __ A.3d __, 2020 WL 7266362 (Del. Dec. 10, 2020). In this decision, the Delaware Supreme Court held that a stockholder who has a “credible basis” to investigate potential wrongdoing or mismanagement need not identify a specific intended use or “end” for the information requested. In addition, the Court clarified that a stockholder need not show, as a matter of law, that the potential wrongdoing is actionable. Rather, a “credible basis” to suspect possible wrongdoing or mismanagement is sufficient.
By brief background, stockholders of AmerisourceBergen Corporation (the “Company”), one of the nation’s largest distributors of prescription opioids, sought to inspect its books and records pursuant to 8 Del. C. § 220. The stockholder-plaintiffs wished to investigate potential wrongdoing or mismanagement relating to the Company’s alleged significant role in the opioid epidemic. Reports of government investigations and pending lawsuits alleged that the Company failed to comply with federal regulations by, inter alia, continuing to do business with suspicious pharmacies and failing to report suspicious orders to regulators. Over 1,500 civil lawsuits were then pending against the Company, with defense costs totaling over $1 billion, and the plaintiffs in those actions having rejected a $10 billion settlement offer. Analysts predicted that the Company may have to pay $100 billion to reach a global settlement.
The stockholder-plaintiffs sought books and records, with their demand letter (“Demand”) indicating purposes of investigating potential wrongdoing or mismanagement to “consider any remedies that may be sought” and to “evaluate litigation or other corrective measures[.]” Before the Court of Chancery, the Company argued that the stockholder-plaintiffs failed to sustain their burden to show a “proper purpose” because the Demand failed to specify the ultimate intended use of the documents or information sought. The Company also argued that a stockholder seeking to investigate potential wrongdoing must identify actionable wrongdoing, which the Company argued they could not do because their potential claims would be time-barred and because the Company’s directors were independent and would be entitled to exculpation. After a trial on a paper record, the Court of Chancery ruled for the stockholder-plaintiffs and rejected the Company’s arguments that they lacked a proper purpose.
Addressing the matter en banc, the Delaware Supreme Court affirmed the Court of Chancery’s decision. The Court first confirmed that a stockholder seeking to investigate potential wrongdoing or mismanagement need not specify the intended uses of any documents requested in her demand. The Supreme Court reasoned that a rule requiring disclosure of intended use made sense in the context of a request for stocklist materials, where it was necessary to assess the propriety of the purpose. Such a rule was inapt when the purpose is to investigate potential wrongdoing, where precedent recognizes that permitting an inspection upon the requisite showing of a “credible basis” serves the interests of all stockholders. Defendant-corporations remain able to inquire into the stockholder’s purposes and any intended use, and the Court of Chancery remains able to find the facts concerning such issues – all of which may inform the “proper purpose” inquiry. A stockholder, however, need not know the specific “ends” of the inspection, provided that she has a “credible basis” to suspect possible wrongdoing.
Regarding the Company’s alternative argument – that a stockholder must identify a basis to suspect “actionable wrongdoing” that may be remedied by litigation – the Delaware Supreme Court reasoned that the Demand properly asserted non-litigation purposes, which rendered it unnecessary to address the issue. But, to provide clarity in this area, the Supreme Court further explained: “we have stated that a stockholder is not required to prove that wrongdoing occurred, only that there is possible mismanagement that would warrant further investigation.” The Court reasoned that this approach struck the appropriate “balance” between stockholders’ informational rights and the rights of directors to manage the corporation without undue interference. It also was consistent with the intended “summary” nature of books and records proceedings to avoid evaluating merits-based defenses over the conduct stockholders seek to investigate. On the other hand, the Delaware Supreme Court reasoned that, in the rare case where bringing litigation is the sole purpose for a demand and such litigation would be barred due to an “insurmountable procedural hurdle,” the Court of Chancery remains able to deny an inspection. However, courts applying Section 220 generally should “defer the consideration of defenses that do not directly bear on the stockholder’s inspection rights, but only on the likelihood that the stockholder might prevail in another action.” The Delaware Supreme Court accordingly held “[t]o obtain books and records, a stockholder must show, by a preponderance of the evidence, a credible basis from which the Court of Chancery can infer there is possible mismanagement or wrongdoing warranting further investigation. The stockholder need not demonstrate that the alleged mismanagement or wrongdoing is actionable.”
Juul Labs Inc. v. Grove, 2020 WL 4691916 (Del. Ch. Aug. 13, 2020). This decision holds that, pursuant to the internal affairs doctrine, inspection rights for a stockholder of a Delaware corporation are governed exclusively by Delaware law, not by laws of other jurisdictions, regardless of where a company’s principal place of business is located.
JUUL Labs is a privately held Delaware corporation with a principal place of business in California. After a JUUL Labs stockholder based his demand on California state law and threatened to bring suit in California state court to enforce his inspection rights, JUUL Labs sought declaratory relief in the Court of Chancery. JUUL Labs argued that the stockholder waived his inspection rights under certain form agreements; that in any event, Grove’s default statutory inspection rights were governed by Section 220 of the Delaware General Corporation Law (“DGCL”), not under Section 1601 of the California Corporations Code; and that the Court of Chancery had exclusive jurisdiction due to a forum-selection provision in JUUL Labs’ certificate of incorporation. Each side moved for judgment on the pleadings.
The Court first held that JUUL Labs failed to show that the stockholder was a party to an agreement reflecting the clear and affirmative language necessary to waive statutory rights. While some language purported to waive rights under Section 220 of the DGCL, none expressly referenced the California Corporations Code. Accordingly, it was necessary to determine what, if any, inspection rights the stockholder had under California law.
In this regard, the Court reasoned that stockholders’ statutory inspection rights are a core matter of the internal affairs of a Delaware corporation. Precedent from the U.S. Supreme Court and the Delaware Supreme Court requires that, where the laws of the state of incorporation differ from those of another state, the former govern matters relating to the corporation’s internal affairs. This is necessary as a matter of due process to provide certainty over which state’s laws apply. Reviewing California law in detail, the Court concluded that, while California’s books and records statutes were not “radically different” than Delaware’s, “California’s balancing of the competing interests between stockholders and the corporation differs from Delaware’s.” And California was not alone in granting inspection rights to stockholders of foreign corporations, creating a risk that “a Delaware corporation could be subjected to different provisions and standards in jurisdictions around the country.” Therefore, under the internal affairs doctrine, Delaware law applied. Relatedly, the terms of a Delaware exclusive forum provision in JUUL Labs’ certificate of incorporation applied, and the stockholder was required to bring any claim to enforce inspection rights in the Court of Chancery.
The Court granted JUUL Labs judgment on the pleadings. In doing so, the Court noted it was not deciding whether purported waivers of the stockholder’s statutory inspection rights under Section 220 in JUUL Labs’ form agreements would be enforceable. While some Delaware cases have not respected such waivers when located in a corporation’s constituent documents, waivers in a separate agreement might be viewed differently. Because the stockholder’s demands were not made under Section 220, the Court was not required to decide such issues.
MaD Investors GRMD, LLC v. GR Cos., Inc., 2020 WL 6306028 (Del. Ch. Oct. 28, 2020). This decision confirmed that a stockholder plaintiff’s five business days under Section 220 between demand and suit does not expire until midnight on the fifth business day. The Court further held that the stockholder plaintiffs’ standing to pursue remedies under Section 220 that had been eliminated by merger between the filing and dismissal of its Section 220 action could not be revived under the Court’s equitable powers.
At 5:03 p.m., on the fifth day after serving a Section 220 demand (the “Demand”) on GR Companies, Inc. (the “Company”), MaD Investors GRMD, LLC and MaD Investors GRPA, LLC (together, “Plaintiffs”), filed a complaint to compel inspection of books and records pursuant to 8 Del. C. § 220 (the “Complaint”). The Company filed a motion to dismiss, asserting that Plaintiffs had filed the Complaint prematurely. Plaintiffs filed a cross-motion for leave to amend the Complaint (the “Leave Motion”).
Section 220(c) provides that stockholders may not file a books and records action until the company (1) refuses a demand to provide books and records, or (2) has not replied “within 5 business days after the demand has been made.” Here, the Demand was made on July 9 and the Complaint was filed at 5:03 p.m. on July 16. Because the Company never responded to the Demand, it argued that Plaintiffs could not file the Complaint prior to 12:00 a.m. on July 17. In response, Plaintiffs argued that they complied with the deadline because (1) the Company “refused” the Demand by requesting an extension to respond on July 15, and (2) the response period ended at 5:00 p.m. (the Court’s filing deadline) on the fifth business day following service of the Demand. In rejecting these arguments, the Court found that, because the request for an extension was not alleged in the Complaint, it was not properly before the Court and, in any event, this request did not constitute a refusal under Section 220. The Court also found that Section 220 refers to “business day” not “business hours,” and the commonly accepted meaning of a “business day” is “a twenty-four hour day other than weekends and holidays.”
Having found that the Plaintiffs had filed the Complaint prematurely, the Court held that it did not have jurisdiction over the Complaint or any request to supplement it. Furthermore, the Court held that, despite the fact that Plaintiffs no longer had standing as stockholders that would allow them to file a curative demand (due to the subsequent closing of a merger), there was no “equitable safe harbor” excusing the premature filing of the Complaint.
For the foregoing reasons, the Court dismissed the Complaint with prejudice and denied the Leave Motion.
Pettry v. Gilead Sciences, Inc., 2020 WL 6870461 (Del. Ch. Nov. 24, 2020). This case illustrates that a Court applying Delaware law may award a stockholder attorneys fees and expenses as a means of addressing the overly aggressive defense of a books and records action. Section 220 of the Delaware General Corporation Law permits a stockholder plaintiff who has a “credible basis” to suspect wrongdoing by officers and directors to demand inspection of books and records relating to that misconduct. In this case, plaintiff-stockholders of Gilead Sciences, Inc. (“Gilead”) sought to inspect Gilead’s books and records to investigate misconduct. Gilead was subject to numerous lawsuits and government investigations arising out of alleged anticompetitive conduct, mass torts, breach of patents, and false claims relating to the development and marketing of its HIV drugs. The plaintiffs sought books and records about Gilead’s (1) anticompetitive agreements, (2) policies and procedures, (3) senior management materials, (4) communications with the government, and (5) director questionnaires. Gilead refused to produce any documents, even though the plaintiffs had a credible basis to suspect wrongdoing and the records they sought related directly to the misconduct. The Court of Chancery found that “Gilead exemplified the trend of overly aggressive litigation strategies by blocking legitimate discovery, misrepresenting the record, and taking positions for no apparent purpose other than obstructing the exercise of Plaintiffs’ statutory rights.” The Court, therefore, granted plaintiffs leave to move for fee shifting.
Alexandria Venture Investments, LLC v. Verseau Therapeutics, Inc., 2020 WL 7422068 (Del. Ch. Dec. 18, 2020). In a dispute over a stockholder’s request for books and records, the Court held that the stockholder plaintiffs only needed to provide a credible basis for the court to infer wrongdoing, they did not need to state that the conduct to be investigated was actionable. The Court limited the stockholders’ inspection to the materials necessary to investigate the claims of wrongdoing and would not allow broad inquiry into the company’s financial condition.
Verseau Therapeutics, Inc. (the “Company”) is a company that is developing immunotherapies to treat certain cancers. Alexandria Venture Investments, LLC and Alexandria Equities No. 7, LLC (“Alexandria”) are stockholders in the Company. In 2020, the Company was seeking additional financing due to the likelihood it would run out of operating funds by early 2021. Alexandria made a financing proposal to the Company that included restrictions on cash payments to directors and Alexandria approval of related party transactions. The Company’s board rejected the financing proposal at an early June meeting. At that meeting, one of the directors indicated that his firm was working on an alternative bridge financing proposal that he believed would be more attractive to the Company. The Company’s board considered the Alexandria financing proposal again at a late June meeting and rejected the proposal.
On July 1, Alexandria made a books and records demand on the Company to investigate whether the board had breached its fiduciary duties in rejecting Alexandria’s proposed financing. Alexandria was unaware at the time of the demand of the June 29 board meeting. Alexandria then made a supplemental demand on July 9 related to the second rejection of its financing proposal. The Company did not respond to the second demand and Alexandria filed suit in the Court of Chancery on July 17.
The Company did not challenge whether Alexandria was a stockholder or had met Section 220’s technical requirements. It only challenged whether Alexandria had stated a proper purpose. Alexandria raised concerns with the Board’s ability to make an unbiased decision on the proposed financing due to the conflicts of interest of several board members. The Company argued that this could not be a proper purpose because the challenged decision had been approved by a majority of the disinterested members of the Company’s board. A fact that was unchallenged by Alexandria’s petition.
The Court rejected the Company’s argument citing the Supreme Court’s decision in AmeriSource Bergen Corp. v. Lebanon County Employees Retirement Fund and held that the appropriate inquiry on a books and records demand is whether the stockholder has alleged a credible basis from which the court can infer mismanagement. The stockholder is not required to allege an actionable claim to merit inspection. The court held that Alexandria’s allegations of conflict were sufficiently detailed and material to merit inspection of the books and records related to the June board meetings.
The Company did not press its claim that Alexandria had an ulterior motive for its inspection request, therefore the Court did not rule on that issue. Finally, the Court limited Alexandria’s inspection rights to the materials necessary to determine whether a breach had occurred. The Court allowed inspection of the formal board materials related to the June meetings and directed the parties to meet and confer on the extent that the Company’s board informally considered Alexandria’s proposal via text or email and submit a proposed order on additional production.
§ 1.3 Corporate Governance
Blackrock Credit Allocation Income Tr., et al. v. Saba Capital Master Fund, Ltd., 224 A.3d 964 (Del. 2020). The Delaware Supreme Court reversed the Court of Chancery’s decision requiring two closed-end trusts (together, the “Trusts”) to count the votes of Saba Capital Master Fund, Ltd’s (“Saba”) slate of dissident nominees at the Trusts’ respective annual meetings. The Supreme Court ruled that Saba’s nominations were ineligible because Saba had failed to respond to the Trusts’ request for supplemental information within the clear and unambiguous five day compliance deadline in the Trusts’ advance notice bylaws (the “Bylaws”).
In response to Saba’s notice that it planned to present a slate of dissident nominees at the Trusts’ annual meetings, the Trusts sent out supplemental questionnaires (the “Questionnaires”) requesting more information about the slate. Saba failed to make any response to the request within the five business day compliance deadline, and the Trusts declared the nomination notice invalid. In the proxy contest that followed, the Trusts urged stockholders not to return proxy cards sent by Saba.
Saba filed suit and asked the Court of Chancery to enjoin the Trusts from interfering with its attempt to present a slate of nominees. On “a highly expedited and pre-discovery record,” the Court granted Saba’s request and required the Trusts to count the votes for Saba’s nominees. While the Court agreed that the Trusts could request supplemental information from Saba pursuant to the Bylaws, it held that the Questionnaires “went too far” because the information was not “reasonably requested” or “necessary” as required by the Bylaws. The Trusts appealed.
The Supreme Court held that, although the Court of Chancery interpreted the Bylaws correctly, it erred in granting injunctive relief because Saba failed to meet the Bylaws’ clear and unambiguous five day compliance deadline. The Court noted that while concerns about the breadth of the Questionnaires could be valid, Saba should have raised those concerns before the expiration of the deadline. The Court “was reluctant to hold that it is acceptable to simply let pass a clear and unambiguous deadline in an advance-notice bylaw, particularly one that had been adopted on a ‘clear day.’” The Court further noted that “encouraging  after-the-fact factual inquiries into missed deadlines could potentially frustrate the purpose of advance notice bylaws”—to permit orderly meetings and proxy contests and provide fair warning to the corporation. Thus, the Court found Saba’s nominations to be ineligible and remanded the case to the Court of Chancery for further proceedings.
Salzberg v. Sciabacucchi, 227 A.3d 102 (Del. 2020). Reversing the Court of Chancery, the Delaware Supreme Court concluded that federal forum selection clauses, requiring that litigation under the Securities Act of 1933 (“‘33 Act”) only be filed in federal courts, are allowable provisions in a Delaware corporation’s certificate of incorporation or bylaws.
Under recent U.S. Supreme Court precedent, private plaintiffs may bring ‘33 Act claims in either federal or state court. A wave of securities class actions filings in state courts inspired corporations to consider limiting such actions to federal courts through charter or bylaw provisions. A stockholder-plaintiff sued seeking a declaration that provisions designed to limit a plaintiff’s choice of forum for an action arising under the ‘33 Act to federal courts were invalid under Delaware law. The Court of Chancery agreed with the plaintiff, holding that Section 102(b)(1) of the Delaware General Corporation Law (“DGCL”) prohibited a corporate charter from “bind[ing] a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.”
Specifically, under DGCL Section 102(b)(1), a corporate charter may contain (1) “any provision for the management of the business and for the conduct of the affairs of the corporation” and (2) “any provision creating, defining, limiting and regulating the powers of the corporation, the directors, and the stockholders, or any class of the stockholders, … if such provisions are not contrary to the laws of this State.” Citing Boilermakers Local 154 Ret. Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013), the Court of Chancery held that Section 102(b)(1) endowed the corporation only with the power to govern claims arising under the internal affairs of the corporation – in this case, claims addressing “the rights and powers of the plaintiff-stockholder as a stockholder.” A federal securities claim involves a claim of fraud in connection with the sale of securities; the fact that the company involved might be incorporated in Delaware is “incidental” to the claim. Instead, the corporate charter must defer to the rights granted pursuant to the external federal statute, which allows for state and federal jurisdiction.
The Delaware Supreme Court reversed, finding that Section 102(b)(1) endowed Delaware charters with broad powers, and that the statute “bars only charter provisions that would achieve a result forbidden by settled rules of public policy.” The Court reasoned that “corporate charters are contracts among a corporation’s stockholders, … and that, Delaware’s legislative policy is to look to the will of the stockholders in these areas.” The Court agreed that Section 102(b)(1) precluded a charter from purporting to govern the location of filings of actions arising under a corporation’s external affairs, but held that federal securities laws were “Intra-Corporate Affairs” – an area that comprised a band of claims between truly external affairs (such as tort claims) and a corporation’s “internal affairs” (such as stockholder derivative actions). A ‘33 Act claim could be brought by an existing stockholder purchasing more shares, and such a claim would seem to fit within the language in Section 102(b)(1) allowing for provisions “creating, defining, limiting and regulating the powers of the … the stockholders, or any class of the stockholders.” As such, it could not be said that in all cases such provisions were invalid. The Supreme Court also held that corporate bylaws may similarly include such forum selection clauses.
Cty. of Ft. Myers Gen. Employees Ret. Fund v. Haley, 235 A.3d 702 (Del. 2020). The decision is significant for articulating the standard applicable to evaluating director disclosure to fellow directors and what facts are necessary to plead that the business judgment rule does not apply when the plaintiff attacks the interest of only one officer and director.
This case involved a merger of equals, Willis Group Holdings Plc (“Willis”) and Towers Watson & Co. (“Towers”). When the parties announced the deal, market reaction was negative for the Towers stockholders. Analysts noted, for example, that the Towers stockholders’ shares in the exchange ratio were valued at 9% below the unaffected trading price even though the financial performance metrics for Towers were much stronger than those of Willis. In this atmosphere of uncertainty over deal consummation, a representative of Value Act, a large stockholder of Willis, proposed a compensation package (“the Proposal”) to the CEO of Towers, John Haley, who was to serve as the CEO of the combined entity. The Proposal would have significantly increased the upside potential over three years from Haley’s existing compensation plan of $24 million to $140 million. When the parties issued their joint proxy, they did not mention the Proposal, the extent of the post-signing discussions or Value Act’s role in the executive compensation discussions with Haley.
The market reaction was so negative that Towers adjourned its stockholder meeting when it had received only about 43% stockholder approval. Thereafter, the Towers board met to discuss potential revisions to the merger agreement. Haley did not disclose the Proposal at that meeting. The board agreed to increase a special dividend from $4.87 to $10 per share. Plaintiff alleged that, because of his interest in the undisclosed Proposal, this increase reflected the bare minimum necessary to assuage the Towers stockholders. The Towers stockholders later approved the revised deal at a reconvened stockholder meeting.
In the litigation that followed, the Court of Chancery held that plaintiff had failed to allege that the non-disclosure of the Proposal was material because the Towers board knew that Haley was going to be the CEO of the combined entity and that his compensation would be greater because the entity would be larger. Second, the Court held the Proposal was not binding and reflected upside potential only for pie-in-the-sky circumstances. The Court thus held Plaintiffs had not overcome the business judgment rule and dismissed the complaint.
In reversing, the Supreme Court reaffirmed that to state a claim in these circumstances, a plaintiff would have to allege that a director was materially self-interested; that the director failed to disclose his interest to the board; and that a reasonable board member would find the director’s material self-interest a significant fact in their evaluation of the proposed transaction. The Court defined “materiality” as “relevant and of a magnitude to be important to directors in carrying out their fiduciary duty of care in decision-making.” Applying that standard, the Supreme Court held that “Plaintiffs are entitled to an inference that the prospect of the undisclosed enhanced compensation proposal was a motivating factor in Haley’s conduct on the renegotiations to the detriment of Towers stockholders.” The Court noted that the fact that the compensation package ultimately approved post-closing had even greater upside reward led to the reasonable inference that the board and Haley believed the milestones were attainable. The Court also found that Plaintiffs adequately alleged that Haley did not disclose the Proposal to the Towers board. Finally, the Court also found that testimony from a disinterested director who served as Chair of the Compensation Committee that he would have wanted to know about the Proposal indicated that a reasonable director would have viewed the Value Act Proposal as a significant fact in the evaluation of the transaction.
Palisades Growth Capital II, L.P. v. Bäcker, 2020 WL 1503218 (Del. Ch. Mar. 26, 2020). In this case, the Delaware Court of Chancery held that it may void an action by a board of directors – even where the action is not otherwise in violation of the corporate charter or the Delaware General Corporation Law (“DGCL”) – when equity so requires.
Defendant Alex Bäcker (“Bäcker”) was the co-founder and former CEO of the nominal defendant corporation, QLess, Inc., as well as one of its five directors. Following internal employee reports that his leadership was threatening the stability of the corporation, however, the board voted to remove him as the CEO. After initially protesting the decision, Bäcker appeared to approve of the replacement CEO, and likewise appeared to agree with the board’s plans to create a sixth board seat for the newly appointed CEO to occupy. The board therefore scheduled a meeting in November 2019, at which the new CEO board seat would be created and filled by the new CEO.
Prior to the board meeting, all five board seats were occupied: Bäcker and his father held two seats; Palisades Growth Capital (“Palisades”), the majority holder of Series A shares, held one seat; the non-party majority holder of the Series A-1 shares held a fourth seat; and an independent director held a fifth seat. Shortly before the board meeting, however, the non-party preferred shareholder and the independent director both unexpectedly resigned their respective seats, leaving only three directors on the board in advance of the meeting. Believing that he held a 2-1 majority, Bäcker allegedly “seized the moment by scheming with [his co-defendant director] (and counsel) to take control of the Company in advance of the November 15 meeting.” At the meeting, the defendants prevented the expected resolutions from being adopted. The defendants instead, with their two to one majority, voted to terminate the newly appointed CEO, to reappoint Bäcker as the CEO (allowing him to occupy the newly-created CEO director seat), and to appoint a new director to fill Bäcker’s newly-vacant director seat.
In response, Palisades brought a Section 225 action against Bäcker and his father, seeking a declaratory judgment that the defendants’ actions during the meeting were invalid for a multitude of reasons. Palisades’ availing argument was that the defendants’ actions were inequitable, and therefore invalid, because the defendants lured the Palisades director to the meeting under the false pretense of planning to vote to appoint the new CEO as a sixth director and to appoint a replacement for the newly-vacant preferred shareholder seat.
While the Court found that the defendants did not violate any specific provisions of the corporate charter, bylaws, or the DGCL, the Court nevertheless noted “[i]t is bedrock doctrine that this Court will not sanction inequitable action by corporate fiduciaries simply because the act is legally authorized.” The Court clarified that, before equity may be invoked in a case such as this, the defendants (acting as fiduciaries) must be shown to have actually affirmatively deceived the plaintiffs. Here, the defendants represented their intentions to vote the new CEO into a director seat, and even suggested that they believed the new CEO already effectively occupied a director position. In light of this affirmative deception, the Court rendered a decision voiding “all actions taken at the contested November 15 meeting.”
In re WeWork Litig., 2020 WL 7346681 (Del. Ch. Dec. 14, 2020). In this case the Delaware Court of Chancery assessed the claims of competing board committees to authorize and to revoke authorization for litigation against the company’s controlling stockholders and determined that a modified Zapata standard is appropriately used to review such committee decisions.
In this case, the board of directors of The We Company (“Company”) created a special committee (“Special Committee”) to negotiate a multi-step transaction (“MTA”) that would resolve the company’s liquidity crisis as well as transfer majority ownership of the Company from Adam Neumann to SoftBank Group Corp. (“SBG”) and SoftBank Vision Fund (AIV MI) L.P. (“Vision Fund”). Part of the MTA was a tender offer. The tender offer opened, but was terminated by SBG and Vision Fund before it could close. The Special Committee initiated litigation before the Court of Chancery against SBG and Vision Fund for breach of the MTA for failing to make best efforts to complete the tender offer (“Litigation”).
SBG and Vision Fund immediately protested the filing of the Litigation to the Company’s management and board. After receiving these complaints, the board of directors approved the appointment of two new directors to form a committee (“New Committee”) to review the authority for and propriety of the Special Committee’s Litigation. The New Committee subsequently issued a report stating that the Special Committee was not authorized to initiate the Litigation and that the Litigation was not in the best interests of the Company. The New Committee then brought a 41(a) motion to dismiss the Litigation initiated by the Special Committee.
The parties presented multiple standards under which the New Committee’s decision to terminate the Litigation should be evaluated. These ranged from business judgment to entire fairness. The New Committee while advocating that the most stringent standard for evaluating its decision would be business judgment, allowed that the Court could apply the Zapata analysis for evaluating a committee’s decision to dismiss derivative litigation with prejudice. The Court found that a modified Zapata standard of review made the most sense under the circumstances.
In so holding, the Court stated that Zapata was the most analogous standard because the Company was seeking to dismiss litigation through use of a board committee in a scenario with the potential for abuse. The business judgment rule was too lenient and the entire fairness test did not fit the circumstance of action taken by a properly authorized board committee. Under the first prong of Zapata, the Court stated that the Company was required to establish that the New Committee was independent and acted reasonably and in good faith. The Court found that the New Committee was unquestionably independent. But, the Court found that the New Committee did not act reasonably. The Court performed a detailed analysis of the conclusions reached by the New Committee and found that the conclusions reached regarding the authority of the Special Committee to initiate the Litigation and whether the Litigation was in the best interests of the Company were not reasonable. Therefore, the Court denied the motion to dismiss under the first Zapata prong.
The Court recognized that the second Zapata prong allowed the Court to exercise its own judgment in determining whether the Litigation should be dismissed. The Court concluded that given the merits of the underlying breach of the MTA claim, the proximity of trial and the unlikelihood that the stockholders could pursue an alternate remedy to remediate SBG’s and Vision Fund’s alleged failure to use best efforts to close the tender offer that the motion to dismiss should be denied. The Court recognized that the Special Committee was not without conflict but in balancing the overall harm to the minority stockholders from dismissing the litigation with the potential for conflict, the Court held that the Litigation should be allowed to proceed.
Pascal v. Czerwinski, 2020 WL 7383107 (Del. Ch. Dec. 16, 2020). This decision affirms that a direct claim for failure to disclose against a board of directors must meet a materiality threshold before it will provide a basis for relief. The plaintiff stockholder’s failure to allege that material information had been withheld was the basis for the court’s dismissal of the direct disclosure claim.
Plaintiff stockholder asserted direct and derivative claims against the board of directors of Columbia Financial, Inc. (“Columbia”) for breach of fiduciary duties related to the approval of bonuses for the directors. The derivative claims are not addressed in the opinion. The direct claim alleged a breach of duty due to failure of the board to adequately disclose material information related to the equity incentive plan when seeking stockholder approval. The stockholder requested that the entire equity incentive plan be voided for this failure to disclose.
Directors have a common law duty to disclose material information to stockholders when seeking their approval for corporate action. Information is material if, from the perspective of a reasonable stockholder, the information is substantially likely to significantly alter the total mix of information. Here the plaintiff stockholder alleged that the directors’ disclosure of the equity incentive plan indicated that it was to be an incentive for future performance. Plaintiff alleged that the equity incentive plan as adopted was actually intended to reward the directors for past efforts in taking Columbia public. As the Court framed it, the issue to be decided was whether the directors’ disclosure of the intent to compensate themselves generally as opposed to specific disclosure that compensation was for past performance related to taking Columbia public was material to stockholder approval of the equity incentive plan.
The Court analyzed the plaintiff’s two allegations of omission of material information. In reviewing the proxy statement, the Court held that it was clear that the board intended the awards to compensate the board for past performance. While the proxy statement did not specifically discuss the going public transaction, the Court held the failure to identify the specific event was not material. The plaintiff stockholder additionally complained of the failure to disclose the peer group of going public transactions on which compensation under the equity incentive plan would be modeled. The court found that adequate disclosure of the peer group that formed the basis for the plan was made in the proxy statement.
The Court dismissed the direct stockholder claim for breach of duty in failing to make adequate disclosures because the complaint did not allege any material undisclosed information that would have been likely to affect the stockholder approval of the equity incentive plan. The Court reserved the questions on the fairness of the equity incentive plan approved for consideration as part of the derivative breach of fiduciary duty claims.
§ 1.4 Mergers & Acquisitions
In re Tesla Motors, Inc. S’holder Litig., 2020 WL 553902 (Del. Ch. Feb. 4, 2020). The Delaware Court of Chancery denied plaintiffs’ and defendants’ (including Elon Musk’s) motions for summary judgment on the grounds that genuine issues of material fact still remain to be determined at trial. The plaintiffs brought the action based on the allegation that Musk improperly influenced the Tesla board of directors to approve Tesla’s acquisition of SolarCity, another entity owned partially by Musk that was purportedly on the verge of insolvency.
The defendants asserted that the acquisition of SolarCity was approved by a fully informed and uncoerced vote of the minority stockholders, and therefore subject to business judgment review under Corwin. After discovery, defendants argued that there was no evidence that Musk, who controlled only a minority (22.1%) of Tesla’s voting power, had actually coerced Tesla’s other stockholders into approving the transaction, and on that basis sought summary judgment. The Court reasoned, however, that if Musk was found to be a controller and had the ability to exercise control over the vote, regardless of whether he actually did so, the transaction would remain subject to entire fairness review. In that regard, the Court explained that Delaware law recognizes that a controller can exert “inherent” coercion over shareholders facing a vote to approve a transaction. As articulated by the Court: “That conflicted controller transactions are inherently coercive … is a fixture of our law endorsed by our highest court and re-emphasized in numerous decisions of this Court.”
The Court acknowledged that leading Delaware jurists, through scholarly articles, have questioned why concerns about “inherent coercion” should justify imposing entire fairness review upon a transaction that rational investors have approved by a fully informed vote. Yet the Court also reasoned that Delaware Supreme Court precedent recognized the doctrine, which was dispositive. Accordingly, if Musk were a controller at the time of this acquisition, his status as such would result in a presumption of “inherent coercion” that prevents Corwin from securing business judgment review.
The Court found it could not, on the current record, determine whether Musk was a controller. Nor could it determine whether or not the stockholder vote was fully informed, or whether a majority of the board was independent when it approved the acquisition. Accordingly, the case will continue to trial, and should Musk be determined to be a controller, the transaction will be reviewed under an entire fairness standard.
Voigt v. Metcalf, 2020 WL 614999 (Del. Ch. Feb. 10, 2020). This decision contains an instructive review of the factors the Court of Chancery will examine to determine whether a minority stockholder may in fact be a controlling stockholder in the circumstances of a specific transaction.
In July 2018, NCI Building Systems, Inc. (the “Company”) acquired Ply Gem Parent, LLC. At the time, a private equity firm (“CD&R”) owned 34.8% of the Company and had four designees on the Company’s twelve-member board. CD&R also owned 70% of the Ply Gem Parent. Company stockholders sued, alleging that three months before the transaction Ply Gem Parent was valued at roughly half the merger price, and accordingly that CD&R and various directors breached their fiduciary duties.
Addressing the defendants’ motion to dismiss, the Court analyzed a number of factors supporting a pleadings-stage inference that CD&R controlled the Company. Among other things, the Court examined the detailed rights CD&R obtained via a stockholders’ agreement, including consent (or veto) rights over matters that otherwise would be board-level decisions. CD&R also had other avenues of board influence, including a right to proportionate representation on committees. In addition to appointing four CD&R insiders to the board, CDR also had longstanding ties to two others, whom it had repeatedly appointed to boards paying significant directors’ fees. The Company’s public filings also indicated that, subject to their fiduciary duties, those two directors’ appointment furthered CD&R’s ability to exercise control at the board level. CD&R also had influence over two more directors by virtue of their employment as officers and, for one, an anticipated promotion in the post-transaction company. Although a special committee was used, it chose a financial advisor with a current relationship with CD&R without interviewing other candidates. The committee also chose not to interview or hire its own counsel, opting instead to proceed with Company counsel.
Of particular note is the Court’s discussion of how a non-majority equity stake factors into the control analysis. The Court observed that “simple mathematics” shows that “a relatively larger block size should make an inference of actual control more likely.” Even a “large stockholder with less than a majority of the voting power retains considerable flexibility to take action at a meeting” because “stockholders who oppose the blockholder’s position can only prevail by polling votes at supermajority rates.” The Court explained that a 35% blockholder like CD&R will win any vote so long as just one out of every seven other shares votes similarly, whereas opponents need to win over 90% of the unaffiliated votes. Thus, even though CD&R held less than a majority, its 35% position lent itself to a pleadings-stage inference of control.
As to the breach of fiduciary duty claim against the directors, the Court concluded that four of the directors were exculpated under a Section 102(b)(7) provision in the Company’s certificate of incorporation, because there were no properly plead allegations that they engaged in intentional wrongdoing – i.e., bad faith. Otherwise, the Court rejected a call by the CD&R-designated directors to dismiss them because they abstained from voting on the transaction. At the pleadings stage, the Court could not conclude that they did not participate in the negotiation or approval of the transaction, so the claim survived.
DLO Enterprises, Inc. v. Innovative Chem. Prods. Grp., 2020 WL 2844497 (Del. Ch. Jun. 1, 2020). Defendants/Counterclaim Plaintiffs (“Buyers”) acquired substantially all of the assets of Arizona Polymer Flooring, Inc., later renamed DLO Enterprises, Inc. (“Sellers”). Sellers filed this action disputing who was financially responsible for certain defective products. During discovery, Sellers produced several pre-closing communications with their counsel that were redacted in part to protect the privilege. Buyers filed a motion to compel unredacted copies of the documents.
In denying Buyers’ motion, the Court found that the right to waive privilege over these documents did not pass to Buyers either by law or contract. The Court of Chancery has held that, in the merger context, the privilege over all pre-merger communications passes to the surviving corporation under Delaware statutory law (i.e., 8 Del. C. § 259) unless there is an express carve out in the merger agreement. See Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, 80 A.3d 155 (Del. Ch. 2013). The Court, however, reasoned that the same default rule does not apply when there is an asset purchase rather than a merger. In an asset purchase, the seller still exists and holds any assets and related privileges that were not explicitly purchased under the asset purchase agreement. Under the Purchase Agreement between Buyers and Sellers here, Buyers did not contract for the right to assert or waive privilege over Sellers’ communications about the transaction; therefore, that right remained with the Sellers.
The Court requested supplemental briefing on the issue of Sellers’ communications with counsel that were in Buyers’ possession because the email accounts were transferred to Buyers in the transaction. The Court noted, however, that upon realizing that they had potentially privileged documents, Buyers’ counsel should not have reviewed the content of those documents and should have segregated them pending resolution of the dispute. The Court held that, should any of those documents be found to be privileged, Sellers’ counsel may file a letter outlining any relief that they deem to be appropriate for Buyers’ review of such documents.
Morrison v. Berry, 2020 WL 2843514 (Del. Ch. Jun. 1, 2020). This decision held that even if fiduciary duty of care claims against a target company’s board of directors are exculpated, an aiding-and-abetting claim against a financial advisor to the board may survive a motion to dismiss when the advisor is alleged to have knowingly misled the board and prevented the board from running a reasonable sales process.
The Apollo group of equity investors sought to acquire the Fresh Market grocery store chain in a going-private transaction in conjunction with other large equity holders. Fresh Market relied on its financial advisor, J.P. Morgan Securities, LLC (“J.P. Morgan”), which during its negotiations with Apollo generated downward adjustments to management projections and adjustments to its discounted cash flow analysis that resulted in a lower valuation range for Fresh Market. Apollo had paid J.P. Morgan $116 million in fees in the two years preceding the transaction. Throughout the sales process, Apollo allegedly communicated with its “client executive” at J.P. Morgan to solicit inside information about the bid process and negotiating dynamics. J.P. Morgan’s conflict of interest disclosures to Fresh Market’s board of directors indicated its “senior deal team members” were not currently “providing services” for the members of J.P. Morgan’s Apollo coverage team. The Court agreed with the plaintiffs that one could reasonably infer this disclosure was “artfully drafted” to omit the backchannel communications with Apollo. The Court found it reasonably inferable that Apollo outlasted other potential buyers and was able to acquire Fresh Market due to J.P. Morgan’s assistance.
The Court of Chancery thus held that at the pleadings stage, the plaintiff’s aiding-and-abetting claim against J.P. Morgan was legally sufficient. The Court reasoned that where a conflicted financial advisor has prevented the board from conducting a reasonable sales process, the advisor may be liable for aiding and abetting the board’s breach of fiduciary duties even if the individual directors are exculpated from liability for their breach. The Court explained that while Fresh Market’s directors were exculpated from their alleged duty of care breach of failing to comprehend J.P. Morgan’s conflict of interest, J.P. Morgan could nevertheless still be liable for aiding and abetting their breach of the duty of care based on its misleading statements, which prevented the board from conducting a reasonable sales process.
In re Homefed Corp. S’holder Litig., 2020 WL 3960335 (Del. Ch. Jul. 13, 2020). This case illustrates that a Court applying Delaware law will apply the entire fairness standard to review a squeeze-out merger by a controller, if the controller engages in substantive economic discussions before the company has enacted the procedural protections outlined in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014) (“MFW”) that would permit business judgment review.
In this case, Jefferies Financial Group Inc. (“Jefferies” or the “Controller”), which owned 70% of HomeFed Corporation (“HomeFed”), acquired the remaining shares of HomeFed in a share exchange in which each HomeFed minority shareholder received two Jefferies shares in exchange for one of its HomeFed shares (the “Transaction”). A HomeFed director originally proposed the 2:1 share exchange to Jefferies in September 2017, and Jefferies subsequently discussed the share exchange with HomeFed’s second largest shareholder Beck, Mack and Oliver, LLC (“BMO”). In December 2017, HomeFed’s board of directors (the “Board”) formed a special committee (the “Special Committee”) that had the exclusive power to evaluate and negotiate a potential transaction. When the parties were unable to agree to merger terms, the Special Committee “paused” its process in March 2018. Despite pausing the Special Committee, Jefferies continued to discuss a potential transaction with BMO for the next year.
In early February 2019, BMO encouraged Jefferies to pursue the Transaction and indicated that it and another significant shareholder would vote for the Transaction. Jefferies announced the proposed 2:1 share exchange on February 19, 2019 (the “February 2019 Offer”) and the Board then reauthorized the Special Committee. During the Special Committee’s negotiations, Jefferies’ CEO reached out to BMO without the authorization of the Committee and implied that the 2:1 share exchange was a “take it or leave it” offer. The Special Committee and a majority of the minority shareholders approved the Transaction in May and June 2019, respectively.
The plaintiffs, who are former shareholders of HomeFed, claimed that the HomeFed directors and the Controller breached their fiduciary duties. In response, the defendants requested the Court of Chancery dismiss the case because the Transaction is subject to the business judgment rule under MFW. In MFW, the Delaware Supreme Court held that the business judgment rule applies to a squeeze-out merger by a controller “where the merger is conditioned ab initio upon both the approval of an independent, adequately-empowered Special Committee that fulfills its duty of care and the uncoerced, informed vote of a majority of the minority stockholders.”
The Court of Chancery denied the motion to dismiss because it found that the plaintiffs adequately pled that Jefferies did not impose the MFW conditions ab initio. This was because, among other things, the Board never dissolved the Special Committee, Jefferies had substantive economic discussions about a potential transaction when the Special Committee was paused, even though the Special Committee had the exclusive power to negotiate a transaction, and BMO consented to the Transaction before the Special Committee even began its negotiations. The Court held that it was reasonably conceivable that the February 2019 Offer was part of the same process that commenced in December 2017. The process failed to comply with MFW because Jefferies did not agree to the MFW protections before the December 2017 process began. Additionally, the Court explained that, even if the February 2019 Offer was part of a new process, the new process also failed to comply with MFW because Jefferies had substantive economic discussions with BMO and obtained the support of BMO and another crucial shareholder in early February 2019, before the Special Committee was reauthorized near the end of February 2019 and before HomeFed publicly announced that any transaction would be subject to MFW’s requirements. Jefferies’ discussions were contrary to the ab initio requirement, which bars the controller from having substantive economic discussions with the minority shareholders, and instead requires that the controller negotiate exclusively with a special committee acting on behalf of the minority shareholders. The Court explained that a controller cannot satisfy the MFW conditions if it undermines the Special Committee by engaging in substantive discussions with minority stockholders before the Special Committee is authorized to act. The Court, therefore, denied the defendants’ motion to dismiss.
In re Baker Hughes, Inc. Merger Litig., 2020 WL 6281427 (Del. Ch. Oct. 27, 2020). This decision arose out of a merger involving Baker Hughes and the oil and gas segment of General Electric (GE). Stockholders of Baker Hughes brought post-closing breach of fiduciary duty claims against certain officers of Baker Hughes and aiding and abetting claims against GE, with the allegations focused on certain financial statements provided by GE in connection with the merger. GE did not maintain separate statements for its oil and gas business line in the ordinary course. The parties accounted for this by having GE prepare unaudited financial statements for that business line and conditioning closing obligations on GE providing audited financial statements that did not differ materially in an adverse manner.
In the ensuing lawsuit, the Court of Chancery dismissed the aiding abetting claim against GE for lack of a predicate breach of fiduciary duty by the Baker Hughes’ board, but upheld a claim for breach of fiduciary duty against the Baker Hughes’ CEO. Among the relevant rulings, the Court rejected the stockholder-plaintiffs’ theory that GE caused the disinterested and independent board of Baker Hughes to breach its fiduciary duties by creating an informational vacuum that induced the board to strike an allegedly bad deal based on the unaudited financial statements. Applying Revlon enhanced scrutiny, and citing, in part, the protections Baker Hughes secured in the merger agreement, the Court found that the Baker Hughes’ board acted reasonably in the circumstances of GE’s consolidated reporting practices. The Court also distinguished the “informational vacuum” decisions advanced by plaintiff (i.e., Rural Metro, PLX, KCG, and TIBCO). Unlike the arms’ length circumstances of this action, each of those cases “involved a player – privy to the internal deliberations or process of a target board that had conflicting financial interests – who deliberately withheld material information from the board, thus casting doubt on the integrity of a sale process.”
The Court, however, upheld a claim against Baker Hughes’ CEO for allegedly breaching his fiduciary duties in connection with the company’s proxy statement. The Court found that the omission of the unaudited financial statements from the proxy in the circumstances was an omission of material information supporting a disclosure violation. This was true even though the information contained in those statements was publicly available in GE’s SEC filings because, as the Court explained, Delaware law “does not impose a duty on stockholders to rummage through a company’s prior public filings” to obtain potentially material information. This disclosure violation prevented the stockholder vote approving the deal from invoking business judgment review under Corwin and supported a claim against the CEO, who was involved in the negotiations, signed the proxy, and conceivably may be liable for breaching his duty of care.
AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC, 2020 WL 7024929 (Del. Ch. Nov. 30, 2020). Parties to a sale and purchase agreement (“SPA”) had planned to close a deal to sell fifteen luxury hotels for $5.8 billion. As the COVID-19 pandemic spread across the globe in early 2020 and battered the hotel industry, the buyer terminated the SPA. Seller sought specific performance in the Court of Chancery. After trial, the Court denied seller’s request for relief.
The Court first noted that the buyer did not have the right to terminate the SPA under its provision for a Material Adverse Effect (“MAE”) simply because a pandemic was ravaging the hotel industry. Seller asserted that the consequences of the COVID-19 pandemic fell within an exception to the definition of an MAE for effects resulting from “natural disasters and calamities.” Though the exception did not explicitly include the term “pandemic,” the Court pointed out that pandemics were included in the dictionary definition of “calamity.” The Court rejected buyer’s argument that a “calamity” had to constitute an MAE under the SPA unless—unlike COVID-19—it was similar to a natural disaster that is a sudden, single event that threatens direct damage to physical property. The Court reasoned that the plain meaning of “calamity” encompassed a pandemic. Surveying case law and commentary concerning MAE clauses, the Court reasoned that this result was consistent with the MAE clause in general, which was relatively seller-friendly. The parties’ competing expert witness analyses of MAE clauses in precedent transactions similarly did not show that sophisticated parties likely would have used the more specific word “pandemic,” as buyer contended. Thus COVID-19 fell within the SPA’s exception to an MAE. Consequently, the Court concluded that the business of the seller did not suffer an MAE as defined in the SPA.
The Court subsequently held, however, that the buyer was entitled to terminate the SPA because the seller failed to comply with its covenants between signing and closing. Seller’s covenants included a commitment that the business of seller would be conducted only in the ordinary course of business, consistent with past practices in all material respects. The Court explained that changes in response to a global pandemic and governmental guidelines did not control over the terms of the SPA. Buyer proved that due to the COVID-19 pandemic, the seller had made extensive operational changes to its hotels’ past-routine business practices. The Court reasoned that “[a] reasonable buyer would have found them to have significantly altered the operation of the business.” The test was not what reasonable managers would do in response to a pandemic. Therefore, the Court found that the seller failed to comply with the “ordinary course of business” covenant, relieving buyer of its obligation to close the deal. There were also complex factual issues involving a fraudulent scheme, title insurance, and the Delaware Rapid Arbitration Act, which also relieved buyer of its obligation to close.
Having concluded that the buyer was permitted to terminate the SPA, the Court denied seller’s request for specific performance. Under the plain language of the SPA, the Court awarded the buyer its $582 million transaction deposit with interest, its attorneys’ fees, and $3.685 million in transaction-related expenses.
§ 1.5 Appraisal
Fir Tree Master Fund, L.P. v. Jarden Corp., 236 A.3d 313 (Del. 2020). Adding to its appraisal jurisprudence, the Supreme Court of Delaware affirmed the use of the unaffected trading price of a public corporation’s stock to determine its “fair value” in the circumstances presented, while clarifying that “it is not often that a corporation’s unaffected market price alone could support fair value.”
After the CEO and co-founder of the respondent corporation negotiated a sale of the company for $59.21 per share, several stockholders refused to accept the sale price and pursued their appraisal rights. Of the valuation methodologies presented at trial, the Court of Chancery determined that only the $48.31 unaffected market price reliably determined fair value. Because of a flawed sale process, a lack of comparable companies to assess, and wildly divergent discounted cash flow analyses, all other valuation methods received little to no weight.
On appeal, the Supreme Court rejected the petitioners’ argument that the Court’s earlier decision in Verition Partners Master Fund Ltd. v. Aruba Networks, Inc., 210 A.3d 128 (Del. 2019) foreclosed, as a matter of law, using the unaffected market price to support fair value The Court surveyed its more recent appraisal opinions in DFC Global Corp., Dell and Aruba. The Court explained that the DFC Global decision took issue with the Court of Chancery’s rejection of the deal price as relevant to fair value and specifically noted that the pre-transaction price of a public company may be relevant to a fair value analysis. In Dell, the Court of Chancery was reversed for assigning no weight to market value or deal price, which the Supreme Court found had substantial probative value in the circumstances of that case. Aruba discussed the considerable weight to be afforded the deal price absent deficiencies in the deal process, because a buyer possessing material non-public information about the seller is better positioned to value the seller when negotiating the purchase price. The Aruba Court further opined that when there were indications that the market was “informationally efficient” – i.e., that it digested and assessed all of the publicly available information such that it was quickly impounded into the stock price – then the market price may be indicative of fair value. The notable “takeaway” from these opinions – which the Supreme Court indicated the court-below got “exactly right” – is the requirement that the Court of Chancery explain its fair value calculation in a manner that is based upon the evidence presented.
Turning to the valuation methodologies presented to the Court of Chancery and its conclusions, the Supreme Court reasoned that the Court of Chancery did not abuse its discretion in rejecting those calculations, in arriving at factual conclusions reached in making that determination and in ultimately relying upon the unaffected market price. The court-below had a basis in the record to conclude that the market did not lack material information about the corporation’s prospects. The record supported the Court’s finding that the divergence of management’s and analysts’ projections was attributable to a difference of opinion, not a material difference in available information. The Supreme Court also declined to find fault with the Court of Chancery’s decision not to rely upon the deal price as a floor for its fair value analysis. The petitioners had attacked the sale process and the deal price it yielded as unreliable and argued to the court-below that synergies were only relevant if the deal price was reliable. After noting this differed from the petitioners’ argument below, the Supreme Court held that the Court of Chancery did not err in reasoning that, based on the record, the deal price included significant synergies. In any event, the trial court did not err in declining to give the deal price weight. The Supreme Court similarly affirmed the court-below’s decision to find certain market evidence more reliable, including the price of share issuances and repurchases occurring near in time, and to find certain other evidence as less reliable, such as certain analysts’ targets or certain results-oriented valuations in the record. Lastly, the Supreme Court held that the Court of Chancery did not abuse its discretion in calculating a terminal investment rate for its DCF model, a method the court used only as a check on the market price, based on convergence theory (also known as the McKinsey formula), as the Court of Chancery has done in certain other recent matters.
Kruse v. Synapse Wireless, Inc., 2020 WL 3969396 (Del. Ch. Jul. 14, 2020). This case illustrates how appraisal works outside of the public market context when a lack of data hinders a reliable valuation. Here, stockholder William Richard Kruse (“Kruse”) sought appraisal of his shares of SynapseWireless, Inc. (“Synapse”), a privately-owned corporation. McWane Inc. (“McWane”) acquired Synapse in two rounds of investments: McWane, first, acquired a controlling interest in 2012, and, then, acquired the remaining Synapse shares in 2016 in a cash-out merger (the “Merger”). As part of the 2012 transaction, McWane gained the right to purchase newly issued Synapse shares at a price set by the 2012 acquisition. Synapse had disappointing performance after the 2012 merger, posting less than half of the projected revenues used to calculate the 2012 merger price. To mitigate Synapse’s poor performance, McWane provided loans and purchased Synapse shares at the price set by the 2012 merger. For example, in 2014, McWane bought $31 million of shares at $4.99 per share to keep Synapse afloat, and to increase McWane’s ownership of Synapse to realize tax benefits.
McWane bought the remaining Synapse shares in the 2016 Merger at $0.43 per share, but Kruse refused McWane’s offer and filed this appraisal action in the Court of Chancery. At trial, Kruse’s expert valued Synapse at $4.19 per share as of 2016, while Synapse’s expert calculated a value between $0.06 and $0.11 per share. Both experts used three valuation methods: (i) a Prior Company Transaction analysis; (ii) a Comparable Transactions analysis, and (iii) a Discounted Cash Flow (DCF) analysis. The Court of Chancery eschewed the first two valuation methods as unreliable, but adopted Synapse’s DCF analysis with minor adjustments. Accordingly, the Court appraised Synapse at $0.23 per share.
In assessing the parties’ contentions, the Court found that, because there was no market check or competitive sales process, there was no contemporaneous market evidence to aid the Court in determining fair value. The Court also ignored a report on Synapse’s value from an investment bank because no employee of the investment bank testified at the trial and hence was not subject to cross-examination.
In lieu of market data, the Court first considered the parties’ Prior Company Transaction analyses. These analyses derived the value of Synapse from the price McWane paid for Synapse shares in prior transactions. Because Synapse had dramatically underperformed the revenue projections used to calculate the 2012 merger price, the 2012 merger price was “stale as of the 2016 Merger.” Additionally, McWane’s purchases of Synapse stock in 2014 were at a price contractually agreed-upon at the time of the 2012 merger, and for that reason did not reflect fair value as of 2016.
The Court next considered the parties’ Comparable Transactions analyses, which estimated the value of Synapse by comparison with other transactions within a similar timeframe, industry and company size. The Court held that neither party had carried its burden to show that its Comparable Transactions analysis reflected Synapse’s fair value. This was because the experts each made thoughtful objections to the other’s analyses, including the comparability of the transactions, and neither expert successfully rebutted the other’s objections.
Finally, the Court evaluated the parties’ DCF analyses. According to the Delaware Supreme Court, a DCF analysis is “widely considered the best tool for valuing companies when there is no credible market information and no market check . . . .” The DCF measures a company’s value by projecting its future cash flows, and then discounting the projections to present value. The Court found Synapse’s DCF calculation more reliable because it better accounted for Synapse’s poor performance, and so adopted the calculation with minor adjustments, finding the fair value on the date of the Merger to be $0.23 per share.
Manti Holdings, LLC v. Authentix Acquisition Co., 2020 WL 4596838 (Del. Ch. Aug. 11, 2020). This decision from the Court of Chancery clarifies the ability of corporate constituents to modify by agreement the rights associated with the statutory appraisal remedy, 8 Del. C. § 262. In a previous decision in the case, the Court denied a stockholder’s appraisal petition holding that an advance waiver of statutory appraisal rights in a stockholder agreement is permitted under Delaware law as long as the relevant contractual provisions are clear and unambiguous. Manti Holdings, LLC v. Authentix Acquisition Co., 2019 WL 3814453 (Del. Ch. Aug. 14, 2019). In its latest decision, the Court ruled that a prevailing party fee-shifting provision in the stockholder agreement did not contravene Delaware law and was likewise enforceable.
In connection with a prior merger of a previous company into the defendant Authentix Acquisition Company, Inc. (“Authentix”), petitioners entered into a Stockholders Agreement with the new stockholders as a condition of that merger. Under the Stockholders Agreement, petitioners agreed that “in the event that … a Company Sale is approved by the Board” they would “consent to and raise no objection against such transaction … and … refrain from the exercise of appraisal rights with respect to such transaction.” Petitioners also agreed to a prevailing party fee-shifting provision “[i]n the event of any litigation or other legal proceedings involving the interpretation of this [Stockholders] Agreement or enforcement of the rights or obligations of the Parties…”
In 2017, the Authentix board of directors approved a merger agreement with a third party. Petitioners refused to consent to the merger, sent appraisal demands, refused to withdraw their demands and filed an action seeking appraisal under 8 Del. C. § 262. After a grant of summary judgment in favor of the surviving corporation because petitioners had validly waived their appraisal rights in the Stockholders Agreement, the surviving corporation sought, and the Court granted, enforcement of the prevailing party fee provision to recover its attorney’s fees.
Acknowledging the contractual fee-shifting provision, the petitioners argued that it was unenforceable for reasons of statutory procedure, public policy and equity. The Court first addressed petitioners’ argument that the Delaware legislature’s enactment of 2015 amendments to §§ 102(f) and 109(b) of the Delaware General Corporation Law (“DGCL”) to proscribe fee-shifting provisions in corporate charters and bylaws for intracorporate litigation, established statutory norms that lower order documents such as stockholder agreements could not contravene. The Court rejected this argument because: (i) neither statutory provision specifically addressed stockholder agreements, and (ii) the legislative history evidenced an intent to carve-out stockholder agreements from the fee-shifting prohibitions. The Court reasoned that the amendment addressed the concern that corporate charters and bylaws, to the extent contractual, are analogous to contracts of adhesion. In contrast, stockholder agreements “signed by the stockholder against whom the provision is to be enforced” fall outside the intended prohibition of the section 102(f) and 109(b) amendments to the DGCL.
Further, the Court observed that the animating concern of the statutory amendments prohibiting fee-shifting was the perverse chilling effect of such provisions on stockholders’ ability to assert and enforce breach of fiduciary duty claims. Noting that breach of fiduciary duty claims were not before him in the appraisal litigation, the court cited the difference between limiting fiduciary duties and waiving statutory appraisal rights as an additional justification for upholding the fee-shifting provision when only appraisal rights are at stake.
§ 1.6 Demand
McElrath v. Kalanick, 224 A.3d 982 (Del. 2020). In this decision the Supreme Court upheld a Court of Chancery dismissal for failure to adequately allege demand excusal. This case exemplifies the Delaware courts’ approach to examining demand futility.
In 2016, Uber Technologies, Inc. (“Uber”) acquired Ottomotto LLC (“Otto”), a company started by a contingent of employees from Google’s autonomous vehicles group, in order for Uber to gain expertise in developing autonomous vehicles. The shareholder-plaintiff brought a claim, on behalf of Uber, against some of Uber’s directors. The plaintiff alleged that Uber’s directors ignored the risks presented by Otto’s alleged theft of Google’s intellectual property, which eventually led to Uber paying a settlement of $245 million to Google and terminating its employment agreement with Otto’s founder.
The plaintiff argued that the directors should have informed themselves of the results of a report prepared by a forensic investigative firm hired by Uber to conduct due diligence on Otto. The report uncovered that Otto employees had misappropriated Google’s intellectual property. More specifically, the plaintiff contended that the directors were on notice to review the report. The directors should not have relied on the representations of then-CEO Travis Kalanick to acquire Otto because Mr. Kalanick had repeatedly flaunted laws applicable to Uber. Plaintiff also alleged that the directors were on notice because of unusual indemnification provisions in the merger agreement between Uber and Otto that protected Otto from liability for some of its disclosed bad acts and misstatements. Finally, the plaintiff claimed that the directors had notice to inquire about the results of the report because they were aware that Uber had requested the forensic investigative firm to prepare the report.
The Delaware Supreme Court affirmed the Court of Chancery’s dismissal of the plaintiff’s complaint because the plaintiff had failed to allege that a majority of Uber’s directors was not disinterested or independent. The Supreme Court held that the mere fact that Kalanick had appointed a director in a control dispute to the Uber board did not lead, without more, to the inference that that director was interested or not independent of Kalanick. In addition, Uber has an exculpatory charter provision, which shields its directors from liability for breaches of the duty of care, meaning that the otherwise disinterested and independent directors could be liable only for intentional misconduct. The plaintiff’s complaint and documents incorporated by reference reflected that the directors discussed the diligence prepared by the forensic accounting firm, were told that the diligence was “OK,” and noted the possibility of litigation with Google. The Supreme Court also found that the directors could have reasonably relied on Mr. Kalanick’s representations because Uber’s alleged past violations of laws under his leadership did not involve intellectual property, and Mr. Kalanick did not have a history of lying to the board. The Supreme Court therefore held that “[a]though there might have been reason to dig deeper into Kalanick’s representations about the transaction, the board’s failure to investigate further cannot be characterized fairly as an ‘intentional dereliction’ of its responsibilities.”
Hughes v. Hu, 2020 WL 1987029 (Del. Ch. Apr. 27, 2020). This decision denied the directors’ motion to dismiss finding that plaintiff had adequately pled demand futility.
According to Plaintiff, for several years Defendants exercised no meaningful oversight over the company’s financial reporting and auditing. This alleged lack of oversight lead to, inter alia, failures to understand and disclose related-party transactions, company funds being held in directors’ personal accounts, and inaccurate financial and tax reporting. Although the company promised to correct these deficiencies in 2014, the problems persisted virtually unabated for three more years. For example, the company continued using problematic auditors, who while purportedly “independent” had no other clients, and the board’s audit committee typically met for less than one hour just once per year. Plaintiff asserted that demand would have been futile because four of the Defendants comprised a majority of the six-member board that would have considered the demand. And some of those same members had also been on the audit committee.
Before turning to the specifics of the case, the Court provided a thorough exposition of the observation that the Court and legal commentators have made for years: the two tests used to evaluate demand futility “ultimately focus on the same inquiry.” The Court began with a casebook-worthy history of the two tests, Aronson and Rales. The earlier Aronson framework applies when the directors who committed the alleged wrong are the same directors who would consider a plaintiff’s litigation demand. Under Aronson, a plaintiff must plead facts which create a reasonable doubt that the directors are disinterested and independent and that the board’s action was a valid exercise of business judgment. The broader Rales framework applies to all situations not addressed by Aronson, such as when the board failed to act or when the board’s membership changed. Rales requires a plaintiff to plead that a majority of directors are “either interested in the alleged wrongdoing or not independent of someone who is.” disinterested and independent and that the board’s action was a valid exercise of business judgment.
As the Court explains it, “[c]onceptually … the Aronson test is a special application of Rales” even though Rales came later. Rales asks generally “whether a director could be interested in the outcome of a demand because the director would face a substantial risk of liability if litigation were pursued” whereas Aronson examines a specific subset when the threat of liability comes from a transaction that the same directors approved.
Using this discussion as a springboard, the Court observed that the case illustrated the overlap between Rales and Aronson. Technically, Aronson would apply because a majority of directors considering the demand were same directors who allegedly failed to provide financial oversight. But because Plaintiff challenged an alleged failure of oversight — i.e., a Caremark claim — rather than a specific board act, the Court determined that the broader Rales standard would typically apply.
The Court concluded that, because the well-pled facts showed a majority of the board faced a substantial risk of liability under Caremark and its progeny, Plaintiff pleaded sufficient facts to establish demand futility. First, the Court concluded that the chronic deficiencies in financial oversight supported a pleadings-stage inference that the board (acting through its audit committee) failed to provide financial oversight or to install a system of financial controls. Defendants attempted to rely upon the fact that the company did have some financial controls – e.g., an audit committee. But Plaintiff had made a pre-suit inspection demand under 8 Del. C. § 220, and obtained books and records showing the board’s activities in this area over the pertinent time period, as well as a certification affirming that the production was complete with respect to its subject matter. The Court criticized the board and audit committee’s general lack of activity despite known problems with financial controls and obtaining transparency into related-party transactions. The Court concluded that the audit committee likely did not fulfill its obligations under its charter. Because of such deficiencies, four of the six board members faced a substantial likelihood of liability for breaching their duty of loyalty, and thus, the board lacked an independent, disinterested majority to consider a demand. The Court denied Defendants’ motion.
Utd. Food and Comm. Workers v. Zuckerberg, 2020 WL 6266162 (Del. Ch. Aug. 24, 2020). The Court of Chancery discussed the legal tests to demonstrate demand futility in derivative actions under the seminal cases of Aronson and Rales. Reconciling longstanding and recent case law, the Court ruled that demand futility turns on whether at the time of filing of the complaint, the majority of a board of directors is disinterested, independent, and capable of impartially evaluating a litigation demand to bring suit on behalf of a company.
This derivative suit followed prior litigation that challenged a proposed, board-approved reclassification of Facebook stock that would have enabled Mark Zuckerberg to sell significant quantities of his stock without attendant stockholder voting rights to maintain his present level of control over Facebook. On the eve of trial in the reclassification litigation, Zuckerberg asked the Facebook board to withdraw the proposed reclassification. The plaintiff then filed derivative claims for breach of fiduciary duties, seeking damages in connection with the board’s approval of the stock reclassification.
The Court held that plaintiff failed to adequately plead demand futility under Court of Chancery Rule 23.1. Conducting a director-by-director analysis of the Facebook board, the Court found that the nine-member board could impartially consider a litigation demand if at least a majority, or five members, could exercise independent and disinterested judgment regarding a litigation demand. Two members were outside directors, who had joined the board after the proposed reclassification had been approved, and plaintiff had failed to plead non-conclusory allegations that called into question their disinterest or independence. For three other members, their alleged business relationships with Facebook or personal relationships with Zuckerberg did not support any inference that they were unable to independently consider a litigation demand. Nor did plaintiff plead any facts that would support a pleading-stage inference that they had received personal benefits from the proposed reclassification or committed a non-exculpated breach of fiduciary duty, and thus could face personal liability in the derivative litigation, as a result of voting to approve the reclassification.
In sum, the Court found that demand was not excused because a majority of the Facebook board was disinterested, independent, and capable of impartially considering a litigation demand regarding the board’s approval of the stock reclassification. Accordingly, the Court dismissed the complaint based on plaintiff’s failure to plead demand futility.
§ 1.7 Advancement and Indemnification
Int’l Rail P’tners v. Am. Rail P’tners, 2020 WL 6882105 (Del. Ch. Nov. 24, 2020). This case considered whether an indemnification provision in a limited liability company agreement covered losses stemming from so-called “first-party” claims (i.e., claims between the parties to the contract, as opposed to so-called “third-party” claims brought by non-parties). The Court of Chancery interpreted the plain language of the provision against a background of advancement and indemnification case law, and distinguished this context from interpretive principles that apply to general indemnification provisions found in commercial contracts.
The individual plaintiff (“Plaintiff”), an officer of the defendant LLC (“Defendant” or the “Company”), brought an action in the Court of Chancery to enforce his rights to advancement under the Company’s LLC agreement. The advancement action arose out of an underlying dispute between the Company and Plaintiff, in which the Company alleged that Plaintiff mismanaged the Company and enriched himself to the detriment of the Company. Based on those allegations, the Company brought an action in the Delaware Superior Court seeking damages against Plaintiff (the “Superior Court Action”). Defendant responded to Plaintiff’s advancement action by arguing that Plaintiff was not entitled to advancement because Plaintiff was defending the Superior Court Action against the Company itself. According to Defendant, the Company’s LLC agreement did not provide for advancement where the claims were brought by or on behalf of the Company against the covered person (which Defendant referred to as “first-party claims”). In reaching this conclusion, Defendant reasoned that the LLC agreement did not expressly address first-party claims and, therefore, no advancement for such claims was allowed—even though the terms of the agreement provided for advancement and indemnification for expenses “arising from any and all claims” against a covered person (as Defendant conceded Plaintiff to be).
The Court rejected Defendant’s arguments, however, and granted judgment on the pleadings to Plaintiff. The Court reasoned that “[i]f Defendant’s position is to be accepted, an LLC Agreement that uses the precise language of the statute to provide for indemnification and advancement to all of its members, managers, and other specified persons as to ‘any and all claims whatsoever’ does not mean what it says.” The Court came to this conclusion despite Defendant’s reliance on Delaware case law relating to indemnification agreements in the bilateral commercial contract context. Those cases suggested that an indemnification provision in a bilateral commercial contract does not operate to shift fees in a claim between parties unless the contract explicitly addresses the issue. The Court noted that the leading Delaware case on this issue was TranSched Sys. Ltd. v. Versyss Transit Solutions, LLC, 2012 WL 1415466 (Del. Super. Mar. 29, 2012). The Court reasoned, however, that TranSched was inapplicable in the LLC indemnification context (under 6 Del. C. §18-108) because TranSched interpreted a standard indemnity clause in a bilateral commercial purchase agreement and was decided in the context of an arms-length transaction between two commercial entities. The TranSched Court reasoned that, if it interpreted such a standard indemnity agreement as shifting attorneys’ fees in a claim between the parties, the American Rule in Delaware would be eviscerated.
As such, the Court found that TranSched did not create a presumption that advancement for first-party claims was disallowed in the Section 18-108 context. Instead, the Court found that LLC indemnification agreements must expressly preclude first-party claims—if the parties wished to do so—reasoning that “[g]iven the statutory framework, the broad language of the LLC Agreement’s indemnification provision, and the strong public policy in favor of indemnification and advancement, … I decline to elevate an interpretive presumption applied to commercial contracts above the strong public policy of advancement and indemnification, particularly in light of the ‘capacious and generous standard’ articulated in the American Rail LLC Agreement.” The Court accordingly ordered the Company to the advance the Plaintiff CEO’s reasonable attorneys’ fees and expenses in defending against the Superior Court Action.
Perryman v. Stimwave Tech., Inc., 2020 WL 7240715 (Del. Ch. Dec. 9, 2020). The Court upheld a charter amendment requiring that advancement agreements for executives be approved by the Series D shareholders. One of the plaintiffs’ advancement agreements was upheld despite the charter amendment, the other was denied as postdating and failing to comply with the charter amendment.
Plaintiffs Laura and John Perryman were directors of Stimwave Technologies Incorporated (“Company”) since 2010 and 2013, respectively. Laura Perryman also served as the Company’s chief executive officer through November 2019. The Company’s original charter adopted in 2010 provided that it would not be amended to change any advancement or indemnification provisions after the initiation of an investigation of any act or omission. The Company’s bylaws further provided that the corporation shall indemnify its officers and directors to the fullest extent permitted by Delaware law.
These provisions remained in place undisturbed until 2018 when the Company solicited additional investors. In connection with a $5 million investment in April 2018, the Company created a new series of preferred shares, Series D. In addition, the Company adopted a charter amendment that stated that the Company would not enter any agreements with its executives except with the approval of 68% of the outstanding Series D shares. A further revision in July 2018 provided that any unapproved agreements with executives were void ab initio.
In October 2019, the Department of Justice initiated a False Claims Act against the Company. In November 2019, Laura Perryman resigned as CEO. Around the time of her resignation she provided the Company with an advancement and indemnification agreement between her and the Company dated January 2018. Pursuant to the terms of the agreement, the Company began advancing fees to Ms. Perryman. In December 2019, the Company initiated a breach of fiduciary duty claim against Ms. Perryman with various allegations of financial misfeasance. The complaint was later amended to include a claim for breach of fiduciary duty against Mr. Perryman as well. Mr. Perryman submitted a claim for advancement to the Company and provided an advancement and indemnification agreement dated January 2015.
There was significant dispute and conflicting evidence about the date Ms. Perryman’s and Mr. Perryman’s advancement and indemnification agreements had been executed. The Court concluded after trial that Mr. Perryman’s agreement had been executed in April 2018 around the time the Company’s board approved entry into such agreement with the directors. The Court further concluded that Ms. Perryman’s agreement had not been executed until November 2019.
The court held that Mr. Perryman’s agreement was not subject to the approval requirements of the charter amendment because he was not an executive. In addition, Mr. Perryman’s agreement was executed while Ms. Perryman was still CEO, therefore it was a valid agreement with and binding on the Company. Mr. Perryman was awarded advancement of his attorneys’ fees and expenses.
Ms. Perryman’s indemnification agreement was executed after the charter amendment, was not approved by the Series D shareholders as a contract with an executive and was not enforceable. In denying Ms. Perryman advancement, the Court further noted that the charter’s provision directing indemnification of the Company’s officers and directors was of no import because advancement and indemnification were separate considerations. Without a valid advancement agreement, the Company had no obligation to advance Ms. Perryman’s legal fees.
§ 1.8 SEC Developments
2020 was a busy year at the Securities Exchange Commission (“SEC”), both in terms of new rulemaking and enforcement actions. But the most material development in terms of its potential effect on Delaware corporate law is a recent proposal Nasdaq submitted to the SEC regarding disclosures related to board diversity and inclusion. Although this proposal potentially raises difficult Delaware corporate law questions, it encouragingly signifies broader institutional support of board diversity initiatives and requirements.
According to Nasdaq, “[i]f approved by the SEC, the new listing rules would require all companies listed on Nasdaq’s U.S. exchange to publicly disclose consistent, transparent diversity statistics regarding their board of directors. Additionally, the rules would require most Nasdaq-listed companies to have, or explain why they do not have, at least two diverse directors, including one who self-identifies as female and one who self-identifies as either an underrepresented minority or LGBTQ+.” Nasdaq’s proposal states that it is proposing the new listing rules because, “[w]hile gender diversity has improved among U.S. company boards in recent years, the pace of change has been gradual, and the U.S. still lags behind other jurisdictions that have imposed requirements related to board diversity. Moreover, progress toward bringing underrepresented racial and ethnic groups into the boardroom has been even slower.”
If Nasdaq’s proposed listing rule passes, Delaware corporate law could be implicated in at least a couple of ways. First, the passage of the listing rule may increase support and momentum for Delaware’s legislature to create statutory board diversity requirements applicable to Delaware corporations—an issue on which the legislature has been silent to date. Second, the rule’s passage may result in litigation that forces Delaware courts to address the contours of the internal affairs doctrine as it relates to non-Delaware-law-based mandates for diversity on the boards of Delaware corporations. Some have forcefully argued that other states’ statutes cannot mandate Delaware corporations’ board diversity. While the proposed listing rule is not a state statute, and may not be viewed as a mandate (given its “adopt or explain” structure), the possibility remains that challenges to the rule under the internal affairs doctrine may arise.
Whatever the outcome of these potential Delaware legislative or judicial endeavors, it is clear that business institutions are moving in the direction of better supporting gender and racial diversity on corporate boards. In addition to the Nasdaq proposal, institutional giants ISS and Glass Lewis have recently improved their policies related to board diversity. Whether these developments prove to encounter resistance when stacked up against Delaware law, or instead harmonize nicely, remains to be seen. In any event, the likelihood that the advancement of board diversity initiatives and requirements will soon require Delaware corporate law to break its silence on the issue is increasing, and fast.
 Press Release, Nasdaq to Advance Diversity through New Proposed Listing Requirements Dec. 1, 2020) (available at https://www.nasdaq.com/press-release/nasdaq-to-advance-diversity-through-new-proposed-listing-requirements-2020-12-01).
 Nasdaq Stock Market LLC, Form 19b-4 (Dec. 1, 2020) at 8 (available at https://listingcenter.nasdaq.com/assets/rulebook/nasdaq/filings/SR-NASDAQ-2020-081.pdf).
 See, e.g., Joseph A. Grundfest, Mandating Gender Diversity in the Corporate Boardroom: The Inevitable Failure of California’s SB 826, Rock Center for Corporate Governance (Sept. 12, 2018) (available at https://www.law.berkeley.edu/wp-content/uploads/2019/10/SSRN-id3248791_3561624_1.pdf).
 See ISS, United States Proxy Voting Guidelines Benchmark Policy Recommendations (Nov. 19, 2020) at 61; Glass Lewis, 2021 Proxy Paper Guidelines: An Overview of the Glass Lewis Approach to Proxy Advice, at 26-27.