Friday, December 12, 2014
The Delaware Court of Chancery recently denied a motion to dismiss in In re Comverge, Inc. Shareholders Litigation. In this case, the plaintiff claimed bad faith by the board of directors that approved an allegedly unreasonable termination fee in a merger agreement. Transactional attorneys and professors who teach M&A will want to read this case.
I am deep into grading my business associations exams, so I will outsource to a nice client alert on the case by Steven Haas at Hunton & Williams. A bit of the alert is below, and you can access the entire alert here.
The court then found that the termination fees of 5.55% of equity value (or 5.2% of enterprise value) during the go-shop period and 7% of equity value (or 6.6% enterprise value) after the go-shop period “test the limits of what this Court has found to be within a reasonable range for termination fees.” The court also analyzed the termination fee in connection with the convertible note held by the buyer in connection with the bridge financing. The plaintiff alleged that the conversion feature in the note, which allowed the buyer to purchase common stock at a price below the merger consideration, would significantly increase the cost to a topping bidder of acquiring the company. Factoring in that cost to the existing termination fee, the plaintiff argued, would result in a total payment equal to 11.6% of the deal’s equity value during the go-shop period and 13.1% of the deal’s equity value after the go-shop period.
The court concluded that, for purposes of surviving a motion to dismiss, it was “reasonably conceivable that the Convertible Notes theoretically could have worked in tandem with the termination fees effectively to prevent a topping bid” from a buyer that might otherwise offer greater value to the company’s stockholders. Perhaps more importantly, the court found that the plaintiff adequately alleged that the board of directors acted in bad faith in approving these terms....
Despite the amount of litigation challenging M&A transactions, there are not many Delaware rulings that have upheld challenges to deal protections such as termination fees, matching rights, and no-shop provisions. This is because the Delaware courts have generally created a body of precedent that provides helpful guidance to buyers and sellers and also recognized the value of such terms. In Comverge, the parties appear to have deviated from this precedent, but more importantly, the court looked to the bridge loan to view the aggregate effect of the various terms on the ability of a third party to make a topping bid.
Monday, December 1, 2014
Well, here we are at the end of another semester. I just finished teaching my last class in our new, three-credit-hour, basic Business Associations offering. (Next semester, I take my first shot at teaching a two-credit-hour advanced version of Business Associations. More to come on that at a later date.) The basic Business Associations course is intended to be an introduction to the doctrine and norms of business associations law--it is broad-based and designed to provide a foundation for practice (of whatever kind). I hope I didn't make hash out of everything in cutting back the material covered from the predecessor four-credit-hour version of Business Associations . . . .
I find teaching fiduciary duty in the corporations part of the basic Business Associations course more than a bit humbling. There is a lot there to offer, and one can only cover so much (whether in a three-credit-hour or four-credit-hour course format). Every year, I steel myself for the inevitable questions--in class, on the class website (TWEN), and in the post-term review session (scheduled for today at 5 PM)--about the law of fiduciary duty as it applies to directors. This past weekend, I received a question in that category on the course website. In pertinent part, it read as follows (as edited for fluency in some places):
I am having problems with understanding the duty of loyalty for directors.
First, . . . I don't think I know which transactions are breaches of loyalty. Do they include interested director transactions, competition, officer's compensation, and not acting in good faith? Second, do care, good faith, and loyalty all require that the directors be grossly negligent? I think I am just confused on the standard to determine whether a director has breached the duty of loyalty and/or care.
Tuesday, November 18, 2014
I’m starting to think that courts are playing the role of Lucy to my Charlie Brown, and proper description of LLCs is the football. In follow up to my post last Friday, I went looking for a case that makes clear that an LLC’s status as a disregarded entity for IRS tax purposes is insufficient to support veil piercing. And I found one. The case explains:
Plaintiff . . . failed to provide any case law supporting his theory of attributing liability to Aegis LLC because of the existence of a pass-through tax structure of a disregarded entity. Pl.'s Opp'n. . Between 2006 and 2008, when 100% of Aegis LLC's shares were owned by Aegis UK, Aegis LLC was treated as a disregarded entity by the IRS and the taxable income earned by Aegis LLC was reflected in federal and District of Columbia tax returns filed by Aegis UK. Day Decl. Oct. 2012 [48–1] at ¶ 37. In the case of a limited liability corporation with only one owner, the limited liability corporation must be classified as a disregarded entity. 26 C.F.R. § 301.7701–2(c)(2). Instead of filing a separate tax return for the limited liability corporation, the owner would report the income of the disregarded entity directly on the owner's tax return. Id. Moreover, determining whether corporate formalities have been disregarded requires more than just recognizing the tax arrangements between a corporation and its shareholders. See United States v. Acambaro Mexican Restaurant, Inc., 631 F.3d 880, 883 (8th Cir.2011). Given the above analysis, the undersigned finds that there is no unity of ownership and interest between Aegis UK and Aegis LLC.
As Charlie Brown would say, "Aaugh!"
So the case makes clear, as I was hoping, that it is not appropriate to use pass-through tax status to find a unity of interest and ownership in a way that will support veil piercing. But the court then screws up the description of the very nature of LLCs. This is not a “case of a limited liability corporation!” It's a case of a limited liability company, which is a not a corporation.
Moreover, to use the court’s language, while it is true that “determining whether corporate formalities have been disregarded requires more than just recognizing the tax arrangements between a corporation and its shareholders,” the premise of the case has to do with an LLC’s status. Thus, the court should, at a minimum, make clear it knows the difference. The statement, then, would go something like this: "Determining whether LLC formalities have been disregarded requires more than just recognizing the tax arrangements between an LLC and its members.”
It’s worth noting the entity formalities for LLCs are significantly less that those of corporations, so the formalities portion of LLC veil piecing test should be minimal, but that's a different issue.
Anyway, like Charlie Brown, I will keep kicking at that football, expecting, despite substantial evidence to the contrary, that one day it will be there for me to kick. At least I don't have to go it alone.
Thursday, November 13, 2014
1) Difference between LLCs, corporations and partnerships
2) Del. and ULLCA coverage of fiduciary duties, and especially the issue of contractual waiver and default
19) No right to distributions, and no right to vote for distributions if manager-managed
20) No right to salary or employment
21) Taxable liability for LLC membership
22) Exit rights—voluntary withdrawals vs. restricted withdrawals, and whether or not that comes with the ability to force the return of an investment or a new status as a creditor of the LLC
23) Liability for improper distributions
24) Veil piercing, particularly given the lack of corporate formalities
I would love some feedback from practitioners as well. What do law students and practicing lawyers need to know about LLCs? What's missing from this list? What should I get rid of? Please feel free to comment below or to email your thoughts to firstname.lastname@example.org.
November 13, 2014 in Business Associations, C. Steven Bradford, Corporate Personality, Corporations, Delaware, Law School, LLCs, Marcia Narine, Partnership, Teaching, Unincorporated Entities | Permalink | Comments (1)
Monday, November 3, 2014
On Monday, The University of Tennessee (UT) College of Law hosted Larry Cunningham to talk about his book, Berkshire Beyond Buffett: The Enduring Value of Values, which he previewed with us here on the BLPB a few months ago in a series of posts (here, here, and here). As you may recall, the book focuses on corporate culture and succession planning at Berkshire Hathaway. Joining Larry at the book session was UT College of Law alumnus James L. (Jim) Clayton, Chairman and principal shareholder of Clayton Bank and the founder of Clayton Homes, one of the Berkshire Hathaway subsidiaries featured in the book. The impromptu conversation between Larry and Jim was an incredible part of the event (although Larry's prepared presentation on the book also was great).
As part of the event, Larry and Jim answered a variety of audience questions. Included among them was a question from UT College of Law Dean Doug Blaze on the role of lawyers in management, transactions, and entrepreneurialism. As part of Jim Clayton's response, he noted the value of preventative lawyering--advising businesses to keep them out of trouble. I was so glad, as a business law advisor, to hear him say that!
Following on that, given that (a) Larry's book focuses on the factors influencing succession planning, (b) I am teaching the Disney case to my Business Associations students this week, and (c) the Disney case is about . . . well . . . failed succession and executive compensation, I asked about management compensation in the context of succession planning at Berkshire Hathaway. Both Larry and Jim (whose son Kevin is President and Chief Executive Officer of Clayton Homes) were clear that Warren Buffett is an exacting manager, but that he believes in paying his portfolio company managers well. Of course, the precise nature of the compensation arrangements of those portfolio firm executives (unlike Michael Ovitz's compensation arrangements at issue in the Disney case) are not a matter of public record. But given the markedly different contexts, I assume the arrangements are very different . . . .
As I approach discussing the Disney case once again in the classroom, I am (as always) looking for new angles, new insights to share with the class (in addition to the core fiduciary duty doctrine). One I will share this year is Jim Clayton's advice about preventative lawyering. What could lawyers have done to reduce the likelihood of controversy and litigation? I have some thoughts and will develop others in the next 24 hours. Leave your thoughts here, if you have any . . . .
Friday, October 24, 2014
Ello is a Delaware public benefit corporation. The social enterprise terminology is proving difficult, even for sophisticated authors at the New York Times Dealbook. The article calls Patagonia and Ben & Jerry’s public benefit corporations. Patagonia, however, is a California benefit corporation. I wrote about the differences between public benefit corporations and benefit corporations here. Ben & Jerry’s is a certified B corporation, but, as far as I know, Ben & Jerry’s has not yet made the legal change to convert to any of the social enterprise forms. I wrote about the differences between benefit corporations and certified B corporations here and here. Just as my co-blogger Joshua Fershee remains vigilant at pointing out the differences between LLCs and corporations, so I will remain vigilant on the social enterprise distinctions.
Besides my nitpicking on the use of social enterprise terminology, there are a few other things I want to say about this article.
First, Ello raised $5.5 million dollars, which is not that much money in the financial world, but puts Ello in pretty rare company in the U.S. social enterprise world. The vast majority of U.S. social enterprises are owned by a single individual or family; some social enterprises have raised outside capital, but not many. The increasing presence of outside investors in social enterprise means two main things to me: (1) the social enterprise concept is starting to gain some traction with previously skeptical investors, and (2) we may see a shareholder derivative lawsuit in the near future, which would give us all more to write about.
Second, Ello included a clause in its charter that “forbids the company from using ads or selling user data to make money.” This provision seems a direct response to the eBay v. Newmark case. The business judgment rule provides significant protection to directors and, at least theoretically, should calm many of the fears of social entrepreneurs. But risk adverse individuals may seek additional layers of protection.
Third, Ello claims that their charter provision “basically means no investor can force us to take a really good financial deal if it forces us to take advertising.” This seems overstated. Charters can be amended, but at least the charter puts outside investors on notice. This provision in the charter does not, however, protect against a change of heart by the founders and a selling of the company (such as in the case of Ben & Jerry’s sale to Unilever).
Fourth, this October 4, 2014 article claims that Ello is pre-revenue. The NYT Dealbook article notes that “[u]sers will eventually be able to download widgets and modifications, paying a few dollars for each purchase.” (emphasis added). Ello seems to be one of the growing number of technology companies that are being valued by number of users rather than by revenues or profits. Ello “grew from an initial 90 users on Aug. 7 to over a million now, with a waiting list of about 3 million.”
Fifth, even if traditional investors are (somewhat) warming up to social enterprises, social entrepreneurs still seem to be a bit skeptical of traditional investors. When raising money, Ello "drew the attention of the usual giants in the venture capital world. . . . But Mr. Budnitz said he instead turned to investors whom he could trust to back the start-up’s mission, including the Foundry Group, whom he came to know when he lived in the firm’s hometown, Boulder, Colo.” There are increasing sources of capital for social enterprises from investors who also have a stated social goal (See, e.g., JP Morgan’s May 2014 survey of impact investors).
Some in the academic world have wondered if social enterprise is just a fad. While I am confident that the space will and must continue to evolve, if it is a fad, it has already been a long-running one. The names and details of the statutes may change, but I see a growing interest in marrying profit and social purpose, and I think that interest is likely to continue in some form.
Cross-posted at SocEntLaw.
The abstract reads:
Nearly thirty years ago, in Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., the Delaware Supreme Court famously dictated that in certain transactions involving a “sale or change in control,” the fiduciary obligation of a corporation’s board of directors is simply to “get the best price for the stockholders.” Applying a novel remedial perspective to this iconic doctrine, in The Dwindling of Revlon, Professor Lyman Johnson and Robert Ricca argue that Revlon is today of diminishing significance. In the three decades since, the coauthors observe, corporate law has evolved around Revlon, dramatically limiting the remedial clout of the doctrine. In this Essay, I show how two recent Delaware Chancery Court decisions — Chen v. Howard-Andersen and In re Rural Metro — underscore the expansive reach of Revlon and, therefore, the limits of Johnson and Ricca’s thesis. Instead, I suggest the dwindling of Revlon, if it is indeed dwindling, may be best observed from what is happening outside the pressed edges of corporate law, where other competing bodies of business law have emerged rejecting Revlon’s fiduciary mandate.
The article is a nice response to a thoughtful article by Lyman Johnson and Rob Ricca entitled The Dwindling of Revlon.
Both articles are highly recommended.
Monday, September 29, 2014
In recent blog posts, two of my favorite bloggers, Keith Paul Bishop and Steve Bainbridge, have highlighted for our attention Delaware and California statutes providing (differently in each case) that an LLC and, at least in Delaware, its managers and members, are bound by the LLC's operating agreement even if they do not sign that agreement. Bishop notes in his post that the California "RULLCA creates an odd situation in which LLCs are bound by contracts that they did not execute and to which they seemingly are not parties." In his post Bainbridge cites to the Bishop post and another post by Francis Pileggi. Certainly, they all have a point. For students of contract law, the conclusion that a non-party is bound by a contract does not seem to be an obvious result . . . .
The flap in the blogosphere has its genesis in a recent Delaware Chancery Court decision, Seaport Village Ltd. v. Seaport Village Operating Company, LLC, et al. C.A. No. 8841-VCL. The limited liability company defendant in that case raised as its only defense that it was not a party to the limited liability company agreement and therefore was not bound. Unsurprisingly in light of applicable Delaware law, Chancellor Laster found the defense wanting as a matter of law.
This issue has more history than my brother bloggers point out, some of which is included in the brief Seaport Village opinion. I probably don't have all the details, but set forth below is some additional background information that may be useful in thinking about the binding nature of LLC operating agreements. Others may care to fill in any missing information by leaving comments to this post.
The Delaware Supreme Court has held that fairness review in duty of loyalty cases has two elements: fair dealing and fair price. Weinberger v. UOP, Inc., 457 A.2d 701 (1983). Fair dealing focuses on process: questions such as “when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.” 457 A.2d at 711. Fair price focuses on the consideration paid or received in the transaction.
Weinberger says that the two elements of fairness must be considered together, that “the test for fairness is not a bifurcated one between fair dealing and fair price.” Id. But, of course, damages will be measured against a fair price. If that’s the case, I ask my students, does fair dealing really make any difference as long as the price is fair?
A Delaware Court of Chancery opinion, In Re Nine Systems Corporation Shareholders Litigation, (Del. Ch. Sept. 4, 2014), recently dealt with that issue. Vice Chancellor Noble concluded that the procedure followed by the company was unfair, so the element of fair dealing was not met. He decided that the price was fair but, considering the two elements together, decided that the burden of proving fairness had not been met.
Because of his finding that the price was fair, the Vice Chancellor rejected the plaintiffs’ claim for damages. However, he concluded that the court could require the defendants to pay certain of the plaintiffs' attorneys' fees and costs.
I now have an answer for my students. Even if the price is fair, fair dealing can still make a difference. Of course, I’m not sure anyone other than the plaintiffs’ attorneys will be terribly happy with the result.
Wednesday, September 24, 2014
President Judge James T. Vaughn, Jr. of the Delaware Superior Court has been nominated to the Delaware Supreme Court by Governor Jack Markell. Judge Vaughn has served on the Delaware Superior Court for 15 years.
News.Delaware.Gov has more here.
Monday, July 7, 2014
For those interested, the Delaware secretary of state's office informs me that there were 145 Delaware public benefit corporations (PBCs) as of 6/30/14.
Friday, June 6, 2014
Today, Delaware governor Jack Markell announced his nomination of Skadden partner Karen Valihura for the open Delaware Supreme Court position.
Delaware Public Media reports:
Gov. Jack Markell is tapping Karen Valihura for a spot on the Delaware Supreme Court.
Markell announced his choice of the corporate lawyer Friday afternoon.
If confirmed by the state Senate, the 51-year old Valihura will become only the second woman to serve on Delaware’s highest court and will replace retiring Justice Jack Jacobs, who is set to step down June 24th.
Valihura is a partner at Skadden, Arps, Slate, Meagher and Flom, LLP, a private Wilmington law firm, where she’s practiced since 1989, dealing with corporate mergers, acquisitions and fraud claims.
In a statement, Markell touted Valihura’s record of community service and called her an attorney of “uncommon skill, intelligence and integrity.”
Read the remainder of the article here.
Monday, April 14, 2014
Delaware, like most states, has a provision in its corporate statutes allowing corporations to limit directors’ liability for breaches of fiduciary duty. Delaware section 102(b)(7) allows corporations to include in their charter “a provision eliminating or limiting the personal liability of a director to the corporation or its stockholders for monetary damages" for certain breaches of fiduciary duty.
A recent Delaware case plows a huge hole through the protection provided by a section 102(b)(7) charter provision. In the Rural Metro case [In Re Rural Metro Corp. Stockholders Litigation, 2014 WL 971718 (Del. Ch. Mar. 7, 2014)], the Delaware Court of Chancery held that a 102(b)(7) provision does not protect against claims that non-directors aided and abetted a duty-of-care violation by directors, even when the directors themselves are protected.
The Chancery Court’s reasoning is sound. Section 102(b)(7), and the associated charter provision, don’t say there’s no breach of fiduciary duty, just that directors aren’t personally liable for damages. The underlying conduct by the directors is still a breach of fiduciary duty, and injunctive relief is still available, just no money damages.Since there’s still a breach of duty, and the statute says nothing about the liability of aiders and abettors, the court concluded that aiders and abettors can still be liable if: (1) the directors breached their fiduciary duties; (2) the third party knew the directors were breaching their fiduciary duties; and (3) the third party participated in the breach.
The court ultimately held that RBC Capital Markets, LLC was liable for aiding and abetting. I can't do justice to the facts in the space available here; I highly recommend a reading of this important opinion.
The real question is whether the Delaware legislature will let this holding stand. The Chancery Court’s statutory reasoning is sound, but that doesn’t mean the result is necessarily good policy. Investment bankers, brokers, accounting firms, and other third party providers, perhaps even lawyers in some cases, are exposed to the risk of liability under this holding. Even if they ultimately win on the merits, as I suspect many will, the litigation itself will be costly. That cost will, of course, be passed on to the corporations using the services of those third parties.
There’s a possible gain associated with that cost, of course: the possible increased deterrence of breaches of fiduciary duty by corporate directors. But the Delaware legislature, in adopting section 102(b)(7), has already decided that other considerations outweigh the deterrent effect of imposing liability on the directors themselves.
Two Legislative Options
Plugging the Rural Metro hole is easy. A simple amendment to 102(b)(7) would do the trick. But how the Delaware legislature chooses to amend the statute (if it does) is important.
One way would be to authorize corporations to include provisions in their charters protecting not only directors, but also people who aid and abet violations by the directors. If that's all the Delaware legislature did, the protection from liability would not be automatic. Companies with 102(b)(7) exculpation provisions would have to amend their charters to protect aiders and abettors.
A simpler, neater solution would make the protection of aiders and abettors automatic. The legislature could just add a sentence at the end of 102(b)(7) providing that aiders and abettors are not liable when the directors themselves are protected from liability. Something like the following would work: “Unless otherwise specified in the certificate of incorporation, no person shall be liable for money damages for aiding and abetting an action protected by such a provision.” If the legislature did this, no further corporate action would be needed to make this protection effective. Only companies that did not want aiders and abettors protected would have to amend their charters.
Stay tuned to see what, if anything, the Delaware legislature does.
Friday, April 11, 2014
On March 24, the petition for certiorari was denied in the Strine v. Delaware Coalition For Open Government, Inc. case, ending the Delaware Court of Chancery's experiment with arbitration by their sitting judges. (H/T Brian Quinn).
As far as I know, however, sitting judges on the Delaware Court of Chancery still conduct mediation. A Chancellor or Vice Chancellor does not mediate his own cases, but rather mediates the cases assigned to one of the other four judges on the court (if the parties agree to submit to mediation).
More information about the Delaware Court of Chancery's mediation process is here. The benefits of the mediation include:
- Expertise. You would be hard pressed to find someone more knowledgable about Delaware corporate law and the merits of a Delaware Court of Chancery case than a sitting Delaware Chancellor or Vice Chancellor.
- Relatively Inexpensive. The fee is only $5,000 a day, for cases that are already on the Chancery docket, which is a decent amount of money, but is dwafted by the legal fees spent in almost all of these cases. For mediation only cases (cases not already on the docket), there is a $10,000 initial fee and a $5,000 for each additional day.
- Confidential. All mediation proceedings are strictly confidential.
These are many of the same main benefits as the Delaware Court of Chancery arbitration, but, of course, in mediation, the judge is not making a decision, but rather assisting the parties in reaching a voluntary settlement.
According to Steven Davidoff, in the Strine case, "the federal court found that the arbitration proceedings were effectively a civil trial, with no difference in judges, place or proceeding except the secrecy and the arbitral nature."
Mediation, however, is quite a bit different than a civil trial. While the comments of a sitting Chancellor may carry a lot weight with the parties, a mediator does not come to a determination for the party and the parties are able to walk away from the mediation at any time.
In short, judicial mediation carries many of the benefits of judicial arbitration, but the practice of judicial mediation seems to be more difficult to challenge.
Friday, March 21, 2014
Statutory provisions allowing for the formation of Delaware Public Benefit Corporations ("PBCs") went effective August 1, 2013. According to the latest data I have, 87 PBCs have been formed in Delaware .
While 87 is an extremely small number when compared to the more than 1 million entities formed in Delaware, Delaware has already bested all states that have passed a benefit corporation statute, except for California. California, which has a 20 month head-start on Delaware, has 139 benefit corporations.
Some states, like New Jersey and South Carolina have been stuck at fewer than 5 benefit corporations for well over a year.
The group of researchers I am working with now estimates that there are about 350 benefit corporations in the U.S. (including PBCs), though the data is relatively difficult to obtain from the secretary of state's offices and obtaining reliable, complete data is even more difficult.
Currently, there are no significant tax benefits (at the state or federal level) for social enterprises (like PBCs and benefit corporations) in the U.S., but the U.K. recently announced 30% tax relief for their social enterprises. (The U.K. social enterprises are a good bit different than those in the U.S.).
It will be interesting to see if the benefit corporation form increases in popularity or languishes.
Obviously, if tax breaks were given to benefit corporations in the U.S., popularity would likely rise. That said, tax breaks would also likely lead to misuse of the form and the need for additional oversight. (Additional oversight is already in place in the U.K.)
Thursday, March 20, 2014
Governor Markell today announced the nomination of Andre G. Bouchard, widely recognized as one of the country’s premier corporate law practitioners, to serve as the 21st Chancellor of the Court of Chancery. If confirmed by the Delaware Senate, Bouchard would succeed the Honorable Leo E. Strine, Jr., who was sworn in as Chief Justice of the Delaware Supreme Court in February.
Bouchard is a graduate of Boston College and Harvard Law School. Currently, he is the managing partner of Bouchard Margules & Friedlander, P.A in Wilmington, Delaware.
Looks like my friends in Delaware accurately predicted this nomination back in January.
Monday, March 10, 2014
In re Rural Metro Corp: Investment Bankers' Liability for Aiding and Abetting Breaches of Fiduciary Duty
On Friday (March 7, 2014), the Delaware Court Chancery issued Vice Chancellor Laster's 91-page post-trial opinionin In re Rural Metro Corp. S’holders Litig.
The decision holds the investment bank defendant, RMC Capital Markets LLC, liable for aiding and abetting breaches of fiduciary duty by the directors. I have not finished the entire opinion yet, but interested readers can access the full opinion here.
The opinion is sure to be one of the most carefully read Chancery opinions of the year - especially by those in the M&A area - and has already generated a fair bit of commentary. For now, I will outsource to the following:
- Jef Feeley (Bloomberg)
- Liz Hoffman (Wall Street Journal)
- Francis Pileggi (Eckert Seamans)
- Brian JM Quinn (Boston College)
- Jonathan Stempel (Reuters)
- Richards, Layton & Finger