CURRENT MONTH (September 2021)
Delaware Supreme Court Overturns Gentile v. Rosette, Clarifying Direct Versus Derivative Claim Analysis
In Brookfield Asset Management, Inc. v. Rosson, the Delaware Supreme Court overturned its oft-criticized decision in Gentile v. Rosette, 906 A.2d 91 (Del. 2006). Gentile held that a stockholder who allegedly suffers dilution as a result of a controlling stockholder increasing its holdings had standing to pursue a direct claim because a corporate dilution/overpayment claim was “dual-natured” (i.e., direct and derivative). Gentile, however, stood in tension with the Court’s earlier decision in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004), in which the Court articulated a two-part test for determining whether a stockholder’s claim is direct or derivative. The Brookfield Court put to rest the Gentile dual-natured exception in favor of Tooley, and thereby made clear that stockholder plaintiffs will now need to contend with the demand requirement under Court of Chancery Rule 23.1 in controller dilution cases.
By Mark D. Hobson, Halloran Farkas + Kittila LLP
The Delaware Supreme Court recently confirmed the corporate principle that “sophisticated and informed stockholders” of Delaware corporations, who have bargaining power, receive consideration and are represented by legal counsel, can voluntarily waive in advance their appraisal rights under Section 262 of the Delaware General Corporation Law. In Manti Holdings, LLC et al. v. Authentix Acquisition Company, Inc., 2021 WL 4165159 (Del. Supr.), the petitioning stockholders, through counsel, tried to assert that a corporation—unlike other legal entities where the principle of freedom of contract is expressly recognized and given maximum effect, such as a limited liability company or limited partnership—has fundamental, mandatory provisions (e.g., right to bring action to compel a stockholders’ meeting under Section 211, right to review books and records under Section 220, and right to challenge an election under Section 225) that cannot be varied by a contract between the corporation and its stockholders because they “are fundamental features of the corporate entity’s identity,” and the waiver in advance of appraisal rights under Section 262 is such a fundamental, mandatory right.
The facts involved the majority owners of a predecessor corporation that ultimately merged in 2008 with a SPV that became the parent of the predecessor, with the result that the former majority owners became minority owners of the SPV parent corporation. In connection with that merger, all stockholders of the parent corporation entered into a stockholders agreement, which included a provision whereby the stockholders agreed to refrain in the future from exercising their appraisal rights under Section 262 (the “Refrain Obligation”). In 2017, the majority stockholders approved a subsequent merger by written consent, and the merger closed on that same day. Following the closing of this second merger, without knowledge of the merger or being given an opportunity to vote on it, the minority stockholders were provided notice of the merger and the decision by the majority stockholders via written consent, and asked to execute the written consent; this notice informed the non-consenting stockholders that although they may be entitled to certain appraisal rights, they contractually agreed to the Refrain Obligation in the 2008 stockholders agreement. The minority owners held common stock and thus received little to no consideration in the 2017 merger, given the waterfall provision favoring holders of preferred stock. Thereafter, a group of common stockholders filed a petition for appraisal with the Delaware Court of Chancery, which was ultimately dismissed.
In a de novo review of the Court of Chancery’s grant of summary judgment in favor of the parent corporation, the Delaware Supreme Court decided that the Refrain Obligation was a clear, bargained-for waiver of appraisal rights with respect to the 2017 merger; the Court also affirmed other aspects of the decision of the Court of Chancery in this case. The Manti Holdings, LLC case also elucidates Delaware courts’ application of “ordinary principles of contract interpretation.”
Delaware Supreme Court Adopts Refined Test for Analyzing Demand Futility
In United Food and Commercial Workers Union and Participating Food Industry Employers Tri-State Pension Fund v. Zuckerberg, the Delaware Supreme Court unanimously eschewed the long-standing test for determining demand futility set forth in Aronson v. Lewis, 473 A.2d 805 (Del. 1984) in favor of a “universal” three-part test that incorporates principles from both Aronson and Rales v. Blasband, 634 A.2d 927 (Del. 1993). The universal demand futility test adopted in this decision focuses primarily on whether directors are disinterested and independent with respect to the litigation demand rather than the decisions or actions being challenged in the litigation. The Court also held that claims exculpated by a corporation’s Section 102(b)(7) charter provision do not expose a director to a “substantial likelihood of liability” for purposes of the demand futility analysis.