During the first half of 2013, Delaware’s Supreme Court and Court of Chancery issued a number of important decisions with far reaching implications. This is a short overview of several key decisions during that time period.
Starting with what one expert in Delaware corporate law described as one of the “best corporate opinions ever”! the Delaware Court of Chancery in In Re MFW Shareholder Litigation, C.A. No. 6566-CS (Del. Ch. May 29, 2013), addressed a “novel question of law” – what standard of review should apply to a going-private merger conditioned upfront by the controlling shareholder on approval by both a properly empowered independent committee and an informed, uncoerced majority-of-minority shareholder vote – business judgment rule or entire fairness test?
Surprisingly, the question of what standard of review should apply to this situation had never been put directly to either the Court of Chancery or the Delaware Supreme Court. In Kahn v. Lynch, the Delaware Supreme Court held that the approval by either a special committee or the majority of the non-controlling stockholders of a merger with a controlling stockholder would shift the burden of proof under the entire fairness standard from the defendant to the plaintiff.
The court in MFW, in concluding that the business judgment rule should apply, noted:
This conclusion is consistent with the central tradition of Delaware law, which defers to the informed decisions of impartial directors, especially when those decisions have been approved by the disinterested stockholders on full information and without coercion. Not only that, the adoption of this rule will be of benefit to minority stockholders because it will provide a strong incentive for controlling stockholders to accord minority investors the transactional structure that respected scholars believe will provide them the best protection, a structure where stockholders get the benefits of independent, empowered negotiating agents to bargain for the best price and say no if the agents believe the deal is not advisable for any proper reason, plus the critical ability to determine for themselves whether to accept any deal that their negotiating agents recommend to them.
The court also recognized that the Delaware Supreme Court is the final arbiter of all Delaware corporate matters, so this decision leaves corporate lawyers and shareholder counsel with something to think about when advising or evaluating the process for going-private deals until the Delaware Supreme Court rules on the matter which is currently pending before it on appeal.
In Boilermakers Local 154 Retirement Fund v. Chevron Corp. C.A. No. 7220-CS and ICLUB Investment Partnership v. Fedex Corp., C.A. No. 7238-CS (Del. Ch. June 25, 2013) the Delaware Court of Chancery addressed the enforceability of forum selection bylaws providing that litigation relating to the internal affairs of the corporation must be filed only in Delaware.
Plaintiffs charged that the bylaws were: (1) statutorily invalid because they were beyond the board’s authority under Section 109 of the Delaware General Corporation Law (DGCL); and (2) contractually invalid because they were unilaterally adopted by those boards using their power to make bylaws.
The standard of review for this motion was also important in this case. The plaintiffs argued for the traditional test that the court may only grant judgment on the pleadings if there are no material facts in dispute. However, the defendants argued (and the court agreed) that because the motion concerned allegations that the bylaws were invalid in that they were beyond the authority granted in 8 Del. C. § 109(b), the motion was only concerned with the facial statutory and contractual validity of the bylaws and not how the bylaws might be applied in any future, real-world situation. Under Section 109(a) of the DGCL, while the power to adopt bylaws rests with the stockholders, a corporation may, in its certificate of incorporation, confer that power on directors. Under Section 109(b), the bylaws may contain any provision relating to the business of the corporation, the conduct of its affairs, and its rights or powers or the rights or powers of its stockholders, directors, officers, or employees.
Both Chevron’s and FedEx’s certificates of incorporation conferred on the boards the power to adopt bylaws under § 109(a). As a result, any investors who bought stock in those corporations were on notice that (1) the DGCL allows for bylaws to address the subjects identified in 8 Del. C. § 109(b), (2) the DGCL permits the certificate of incorporation to contain a provision allowing directors to adopt bylaws unilaterally, and (3) the certificates of incorporation of Chevron and FedEx contained a provision conferring this power on the boards. Acting in accordance with the power conferred to those boards by the certificates of incorporation, the boards amended the bylaws and adopted a forum selection bylaw to cover certain types of suits relating to internal corporate governance.
Because the certificate of incorporation conferred on the board the power to adopt bylaws, and the board had adopted a bylaw consistent with 8 Del. C. § 109(b), the court found that the stockholders had assented to that new bylaw being contractually binding. As a result, the court found that the bylaws were statutorily and contractually valid.
In Gerber v. Enterprise Products Holdings, LLC, Del. Supr., No. 46, 2012 (June 10, 2013), the Delaware Supreme Court addressed the increasingly important issue of whether a contract provision that presumes good faith can preclude a claim for a breach of the implied covenant of good faith and fair dealing in a limited partnership agreement. Delaware’s high court answered that question in the negative. The court reasoned that the waiver in a limited partnership agreement of the fiduciary duty of good faith, and the substitution of a new contractual definition for good faith, cannot eliminate the implied duty of good faith and fair dealing which cannot be waived in Delaware.
Gerber is the first Delaware Supreme Court decision that directly addresses the issue of whether the presumption of good faith in a limited partnership agreement can, as a practical matter, prevent a claim for a breach of the implied covenant of good faith and fair dealing.
This Delaware Supreme Court decision needs to be distinguished from another recent decision by that court in Brinckerhoff v. Endridge Energy Company, Inc. The Brinckerhoff case also dealt with a presumption of good faith in a limited partnership agreement, but in that decision, the court did not address the effectiveness of that conclusive presumption because the ruling relied on a separate holding that the complaint failed to allege facts that suggested bad faith. The factual background involved an extensive network of multiple related entities involved in a number of labyrinthine transactions.
The applicable agreements established a conclusive presumption when enumerated conditions were satisfied, which provided protection from any claims of conflict of interest. Those conditions included relying on the opinions of experts, and such reliance would be conclusively presumed to have been done in good faith. The court’s reasoning was based on the distinction between the contractually defined duty of good faith, and the similar term that is a component of the implied covenant of good faith and fair dealing. Conflating those two concepts is an error. The court explained that the focus of any analysis under common law fiduciary duty is the action at the time that the wrong took place. By contrast, the focus of any analysis under the implied covenant is the intent of the parties at the time the contract was formed, which is often many years prior to the alleged wrong.
The Delaware Supreme Court emphasized that no contractual provision could eliminate the implied covenant, even on a de facto basis through a conclusive presumption. The high court provided several examples of why the implied covenant could not be “contracted away,” and no provision in an agreement could bar a claim for arbitrary and unreasonable use of discretion that would be a breach of the implied covenant. The court concluded that an implied covenant claim can still be pursued even where, as in this case, the defendant allegedly attempted to satisfy his contractual obligations, within a conclusive presumption provision, by relying on a fairness opinion that did not value the consideration that was actually received by the LP Unitholders.
The court reasoned that it could “confidently conclude” that had the parties addressed the issue at the time of contracting, they would have agreed that any fairness opinion must address whether the consideration actually received was fair in order to satisfy the contractually defined duty, which was the good faith component of a contractually defined duty imposed under the agreement. The court held that a non-responsive fairness opinion that was relied on is “the type of arbitrary, unreasonable conduct that the implied covenant prohibits.” The court compared another of its recent opinions which did not involve claims that the fairness opinion did not state that the merger was fair. See Norton v. K-Sea Transportation Partners L.P.