Malpractice Suit Based on Filing UCC-1 in Wrong State
Juno Investments LLC v. Miller, 2021 U.S. Dist. LEXIS 118776, decided June 25, 2021. The U.S. District Court, District of Delaware denied the defendant lawyers’ motion to dismiss a malpractice suit filed against them by the plaintiff. The plaintiff loaned money to a Delaware LLC of which it was the majority shareholder. The LLC engaged the defendants to provide legal services. The defendants filed a UCC-1 financing statement naming the Delaware LLC as debtor and plaintiff as creditor. However the UCC-1 was filed in North Carolina when it should have been filed in Delaware. Plaintiff claimed the defendants' failure to file the UCC-1 in the correct state rendered it an unsecured creditor in debtor’s bankruptcy, thereby causing it damage. In rejecting the motion to dismiss the court noted that (1) the defendants’ claim the plaintiff suffered no damages was mooted by the resolution of the bankruptcy proceedings, (2) the plaintiff did not lack standing to raise its negligence claim based on its not having an attorney client relationship because the plaintiff was asserting a duty as a nonclient, and (3) the plaintiff could maintain its breach of contract claim because its complaint plausibly showed privity of contract or that it was a direct third party beneficiary to the engagement contract between the debtor and defendants.
State of Delaware Department of Finance vs. AT&T Inc., No. 303, 2020, decided June 1, 2021. The Delaware Supreme Court, deciding issues of first impression in Delaware, held that it was adopting the procedures and substance followed by the federal courts in administrative subpoena enforcement proceedings. The court then affirmed the Chancery Court’s decision quashing an administrative subpoena served by the Delaware Department of Finance on a Delaware corporation to produce records relating to a financial audit to determine the corporation’s compliance with the state’s unclaimed property law. The court noted that in most cases the subpoena recipient will have a difficult time convincing the court to inquire further into an agency’s good faith once the agency, as in this case, satisfies the federal test. But under the circumstances of this case, where the court had serious questions but the Department refused to provide answers, the Court of Chancery did not err in quashing the subpoena in its entirety. The court also found that the Court of Chancery did not err when it considered the reasonableness of the subpoena in light of the statute of limitations that was in effect before the 2017 amendments to the unclaimed property law.
Reverse Veil Piercing
Manichaean Capital, LLC v. Exela Technologies, Inc., C.A. No. 2020-0601, decided May 25, 2021. The Delaware Chancery Court, in an issue of first impression, held that Delaware courts will allow for outsider reverse veil-piercing in limited circumstances and in circumscribed execution. The court stated that in reviewing a claim for reverse veil-piercing Delaware courts should consider the so-called “alter ego” factors that include insolvency, undercapitalization, commingling of funds, the absence of corporate formalities, and whether the subsidiary is simply a facade for the owner. The court should then ask whether the owner is utilizing the corporate form to perpetuate fraud or an injustice.
The court then held that this was one of those exceptional circumstances where a plaintiff had well pled a basis for reverse veil piercing. The plaintiffs were creditors of a corporation that was the single member of an LLC, which in turn was the single member of several subsidiaries, and the plaintiffs sought to hold the subsidiaries liable for a judgment held against the member. The court found it reasonably conceivable that the subsidiaries were alter egos and actively participated in a scheme to defraud or work an injustice against creditors, and that no innocent shareholders or creditors of the subsidiaries would be harmed by reverse veil-piercing.
COVID-19 and Material Adverse Effects
Snow Phipps Group, LLC v. KCake Acquisition, Inc., C.A. No. 2020-0282, decided April 30, 2021. The Delaware Chancery Court ordered the buyer to close on its acquisition of a company, thereby rejecting the buyer’s assertion that the acquisition should be terminated based on a material adverse event clause in the sales agreement. The buyer asserted that there was a material adverse change to the company’s business because of COVID-19 . However, the court found that the buyer failed to carry its burden of proving there was a reasonable expectation of a material adverse effect. The court noted that although there was a large downturn in sales at the beginning of the pandemic, sales rebounded quickly and were projected to continue recovering throughout the year. It was not projected to have a sustained drop like in the only case where the Delaware Chancery Court found a material adverse effect to be reasonably expected.
Choice of Law in D&O Policies
RSUI Indemnity Company v. Murdock, No. 154 2020, decided March 3, 2021. The Delaware Supreme Court, in what has been called a “landmark” decision concerning choice of law in the context of a directors and officers (D&O) liability insurance policy, held that Delaware law – and not California law - should be applied in a dispute over whether an excess insurer is obligated to reimburse a Delaware corporation for settlement amounts under a D&O policy where the corporation was based in California, the policy was negotiated and issued to it in California, the officers and directors lived in California, and where its only connection to Delaware was that it was incorporated there.
The court looked at various factors and found they suggested that the state of incorporation is the center of gravity of the typical D&O policy. This included that it is Delaware’s corporation law that allows a corporation to purchase a D&O policy and that Delaware law governs the duties of directors and officers of a Delaware corporation and as such the corporation must assess its need for D&O coverage with reference to Delaware law. And in balancing California’s interest – which was mainly based on physical location, against Delaware’s interest in protecting the ability of its corporate citizenry to secure D&O insurance and thereby attract the best directors and officers, the court found that Delaware had a more significant relationship to the policy and the parties.
As to the issue of whether the insurer was responsible, the court found that it was, rejecting its argument that because there was a finding of fraud it was not liable. The court noted that the policy obligated the insurer to pay for a loss arising from claims for a wrongful act, broadly defined to include a breach of duty – which could include a breach of the duty of loyalty when based on fraud. The court then held that Delaware does not have a public policy against the insurability of losses occasioned by fraud so strong as to vitiate the parties’ freedom of contract.
Noncompliance with Certificate of Incorporation
Lacey v. Mota-Velasco, C.A. No. 2019-0312, decided February 11, 2021. The Delaware Chancery Court dismissed a stockholder derivative claim against a corporation’s directors for breach of contract based on the directors failing to comply with a clause in the certificate of incorporation that required certain transactions to be approved by an independent board committee. The court stated that the complaint did not plead any facts indicating that the directors were bound to the company contractually, aside from pointing to the existence of the certificate of incorporation itself. The relationship between directors and their corporation is typically fiduciary, rather than contractual. And if any claim is created on behalf of the corporation by a failure on the part of directors to comply with the entity’s formative documents, it is a claim for breach of fiduciary duty, not breach of contract.
Production of Records
Wood v. U.S. Bank National Association, C.A. No. 2017-0034, decided February 4, 2021. The Delaware Chancery Court held that an individual member of an LLC could not invoke the privilege against self-incrimination to avoid producing documents of a collective entity that were in his possession in a representative capacity for the entity. The court also held that the collective entity doctrine applies to a single member LLC, as the member and the LLC are distinct for the purposes of the self-incrimination clause.
Standing to Challenge Merger
Morris v. Spectra Energy Partners (DE) GP, LP, No. 489, 2019, decided January 22, 2021. The Delaware Supreme Court reversed the Chancery Court’s granting the defendants’ motion to dismiss for lack of standing, the plaintiff’s direct claim challenging the fairness of a merger based on the defendants’ failure to secure value for derivative claims. The Chancery Court applied a litigation risk discount to the recovery amount the plaintiff pled in determining its materiality. This was an error because the court must accept the plaintiff’s factual allegations as true in assessing standing at the motion to dismiss stage.
Validity of Board Meeting
Backer v. Palisades Growth Capital II, L.P., No. 156, 2020, decided January 15, 2021. The Delaware Supreme Court affirmed the Chancery Court’s invalidating the actions taken at a board meeting in which the appellant seized control of the corporation. The Chancery Court did not err in finding that the appellant, the former CEO who the board had terminated, affirmatively deceived one of the directors in order to get him to attend the board meeting, thereby providing a quorum so that the appellant could put into action his agenda to be reinstated as CEO.
Inspection of Books and Records
AmerisourceBergen Corporation v. Lebanon County Employees Retirement Fund, No. 60 2020, decided December 10, 2020. The Delaware Supreme Court held that when a Sec. 220 inspection demand states a proper investigatory purpose, it need not identify the particular course of action the stockholder will take if the books and records confirm the stockholder’s suspicion of wrongdoing. The court also held that an investigating stockholder is not required in all cases to establish that the wrongdoing under investigation is actionable.
Effect of COVID-19 on M&A Deal
AB Stable VIII LLC v. MAPS Hotels and Resorts One LLC, CA No. 2020-0310, decided November 30, 2020. The Chancery Court held that a company that agreed – pre-COVID 19 – to buy a company that owned 15 luxury hotels was relieved of the obligation to close on the deal because the seller, among things, closed two of the hotels, severely restricted operations at all the others, and laid off thousands of employees due to the pandemic. The court ruled that the seller breached the covenant that required it to operate in the ordinary course of business consistent with past practice in all material respects. The court also found that the buyer could not terminate based on the Material Adverse Effect clause, because an MAE was defined to exclude adverse effects caused by a “calamity” and a pandemic meets the definition of calamity.
In re Solera Insurance Coverage Appeals, Nos. 413, 2019 and 418, 2019, decided October 23, 2020. The Delaware Supreme Court held that an appraisal action brought under GCL Sec. 262 was not a securities claim under a D&O policy that defined a securities claim to include a violation of any law regulating securities. The court held that the plain meaning of the term “violation” suggested an element of wrongdoing and that appraisal proceedings have a neutral purpose—to determine the value of the corporation.
Gulf LNG Energy, LLC v. ENI USA Gas Marketing LLC, No. 22, 2020, decided November 17, 2020. The Delaware Supreme Court held that the Chancery Court has jurisdiction to enjoin a collateral attack on a prior arbitration award. The parties agreed the Federal Arbitration Act governs their dispute. Under the FAA courts have the exclusive power to review and enforce arbitration awards. A party cannot escape the FAA review procedure by filing a follow-on arbitration to attack the outcome of the prior arbitration.
Forum Non Conveniens
Focus Financial Partners, LLC v Holsopple, CA No. 2020-0188, decided November 2, 2020. The Delaware Chancery Court granted the defendant’s motion to dismiss on forum non conveniens grounds in a lawsuit filed by a Delaware LLC arising out of an employee leaving and going to work for the defendant. In evaluating the Cryo-Maid factors, the court found that the fact that a California action filed by the defendant and employee was further along, the predominate role of California law in deciding the issues, and that Delaware lacked jurisdiction over the employee, all weighed against litigating in Delaware.
Definition of “Business Day”
Mad Investors GRMD, LLC v. GR Companies, Inc., CA No. 2020-0589, decided October 28, 2020. The Delaware Chancery Court, in a case of first impression, held that a “business day” for the purposes of Sec. 220(c) of the General Corporation Law expires at 12 midnight and not 5 pm. Sec. 220(c) provides that a stockholder who has demanded an inspection of books and records may not file a lawsuit to compel the inspection until the expiration of 5 five business days after the corporation does not reply to the demand (unless the corporation refuses earlier). The court based its holding in part of the fact that dictionaries indicate that a business day refers to a full calendar day and not a subset of hours and because other sections of the Delaware code define “business day” as a “day” and not limited to hours. The court also distinguished business day from the term “usual hours of busines” as found in Sec. 220(b).
Suit Against Foreign Corporation
Sylebra v. Perelman, C.A. No. 2019-0843, decided October 9, 2020. The Delaware Chancery Court dismissed claims brought by a stockholder in a corporation that was incorporated in Delaware when the stockholder invested but that had since reincorporated in Nevada, seeking to hold provisions of the Delaware bylaws invalid as the bylaws ceased to exist upon the reincorporation. The court also held that the internal affairs doctrine prevented it from declaring provisions of the Nevada corporation’s bylaws invalid under Delaware law, and dismissed the remaining claims under Nevada law because the corporation’s bylaws had an enforceable forum selection clause.
Internal Affairs Doctrine
JUUL Labs, Inc. v. Grove, CA No. 2020-0005, decided August 13, 2020. The Delaware Chancery Court held that a stockholder seeking an inspection of records of a Delaware corporation with its principal place of business in California cannot rely on Sec. 1601 of the California Corporations Code – which grants inspection rights to stockholders of corporations with their principal executive offices in California regardless of the state of incorporation. Under principles articulated by the US and Delaware Supreme Courts, Delaware law governs the internal affairs of its corporations and the scope of a stockholder’s inspection rights is a matter of internal affairs. Therefore, Delaware law applies.
Spanakos v. Pate, No. 532, 2019, decided July 31, 2020. The Delaware Supreme Court affirmed the Chancery Court’s denial of a stockholder’s request under Sec. 223 and 211 for a corporation to hold an annual meeting and elect directors, even though the stockholder met the requirements of those sections. Ordering a meeting is in the court’s discretion, and in this case, where the stockholder was involved in litigation in Florida impacting this case, the Chancery Court, by pointing the stockholder back to Florida for that court to clarify its orders, crafted what it believed was the clearest path to obtaining relief in Delaware.
Duty of Disclosure
Dohmen v. Goodman, No. 403,2019, decided June 23, 2020. The Delaware Supreme Court, answering a certified question from the 9th Circuit Court of Appeals, held that under the facts of the dispute, a general partner’s request to a limited partner for a one time capital contribution did not constitute a request for limited partner action such that the general partner had a fiduciary duty of disclosure. And even if the general partner had a fiduciary duty to disclose, the limited partner could not recover compensatory damages without proving reliance and causation.
Hughes v. Hu, 2019-0112, decided April 27, 2020. The Delaware Chancery Court held that a stockholder filing a derivative suit had established demand futility where the complaint established the board faced a substantial likelihood of liability under Caremark for failing to establish a system of internal controls over the corporation’s financial reporting. The complaint alleged, among other things, the audit committee met sporadically, failed to address known problems, and relied blindly on management instead of establishing its own system of oversight.
Validity of Stockholder Votes and Consents
Palisades Capital II, LP v. Backer, No. 2019-0931, decided March 26, 2020. The Delaware Chancery Court held that an email sent from a stockholder’s lawyer to the corporation’s counsel requesting counsel take actions to facilitate a stockholder consent to appoint a director was neither a vote nor a valid consent. The General Corporation Law requires a meeting for a vote to be valid and a request to take an action, rather than executing an action, is not a valid consent.
Forum Selection Provisions
Salzberg v. Sciabacucchi, No. 346,2019, decided March 18, 2020. The Delaware Supreme Court upheld the validity of a provision in several Delaware corporations’ certificates of incorporation requiring actions arising under the federal Securities Act of 1933 to be filed in a federal court. The court held that federal forum selection provisions fall within the broad enabling text of Sec. 102(b)(1) of the General Corporation Law and are facially valid, are not against public policy, and advance the goal of Delaware courts to achieve judicial economy and avoid duplicative efforts among courts.
Court of Chancery’s Jurisdiction
Hanna v. Baier, CA No. S12J-03-058, decided January 22, 2020. The Delaware Superior Court held that the Court of Chancery was the proper forum to hear an action to enforce a charging order where the plaintiff claimed certain payments made by the Delaware LLC to the debtor member violated the charging order and where the court had to determine if those transactions were authorized by the LLC Act. In addition, the plaintiff was seeking relief which would require the court to pierce the veil, which the Superior Court cannot do.
McElrath v. Kalanick, No. 181, 2019, decided January 13, 2020. The Delaware Supreme Court affirmed the Chancery Court’s dismissal of a derivative suit against a corporation’s board of directors for failure to make a pre-suit demand or allege demand futility. The suit arose out of the board’s approval of a risky acquisition that resulted in the corporation using another company’s proprietary information. The court found that a majority of the directors were independent and disinterested and the complaint failed to allege that the board rubberstamped the flawed transaction or acted in bad faith.