June 2022 in Brief: Business Litigation & Dispute Resolution

Business Litigation

Citing Exceptional Facts, Delaware Court Finds Board Had Compelling Justification to Thwart Stockholder Action

By Leah E. León and Shannon E. German

In a case presenting unusual facts, the Delaware Court of Chancery recently upheld, on remand, a board’s decision to pursue a stock sale to escape a deadlock. In Coster v. UIP Companies, Inc., Chancellor Kathaleen St. J. McCormick had previously found in a post-trial decision that the challenged stock sale was entirely fair. On remand following an appeal, the Chancellor determined that the stock sale did not fall within Schnell’s limited application and that it satisfied review under Blasius.

The late husband of Plaintiff Marion Coster owned 50% of UIP; Defendant Steven Schwat owned the other 50%. After her husband’s death, Plaintiff sought liquidity of the 50% she inherited, but would not accept Defendants’ proposed buyout price. Plaintiff called for special meetings of the UIP stockholders to elect directors to vacant board seats, which resulted in deadlock, so Plaintiff filed a complaint in the Court of Chancery seeking appointment of a custodian. The threat of a court-appointed custodian posed risks to UIP, which in response sold a third of its outstanding but unissued voting equity to a UIP executive. The stock sale had been developed previously as a succession plan “on a clear day before any deadlock loomed.” Plaintiff challenged the stock sale.

In her post-trial decision, Chancellor McCormick found that the stock sale was entirely fair to the UIP stockholders and entered judgment in favor of Defendants. On appeal, the Delaware Supreme Court concluded that the Chancellor should have also evaluated the stock sale under Schnell or Blasius, depending on whether the UIP board’s motives were impure or pure. The Supreme Court identified factual findings in the post-trial decision that could support a determination that the board acted for inequitable purposes under Schnell.

On remand, the Chancellor first analyzed whether the UIP board approved the stock sale for “inequitable purposes” under Schnell. The Chancellor observed that the “elusive nature of Schnell as a standard and the potentially harsh consequences of its application provide good reason to limit Schnell’s application.” Given that, the Court interpreted Schnell, in the context of stockholder-franchise challenges, as “applicable in the limited scenario wherein the directors have no good faith basis for approving the disenfranchising action.” The post-trial decision had found that the board had a good faith basis for pursuing the stock sale: it sought to reward and retain an essential employee, implement a previously contemplated succession plan, and avoid risk of default under key contracts. Thus, despite the Supreme Court’s suggestion to the contrary, the Court of Chancery determined on remand that the board had not acted inequitably under Schnell.

The Court next considered whether, under Blasius, the UIP board approved the stock sale for the “primary purpose of thwarting” Plaintiff’s vote to elect directors or reduce her leverage as an equal stockholder; and if so, whether it had a “compelling justification” for doing so. The Chancellor concluded that the stock sale was for the primary purpose of mooting Plaintiff’s action for appointment of a custodian. Even assuming this triggered Blasius, the Court nevertheless concluded that in the “exceptionally unique circumstances” presented, Defendants met the “onerous burden of demonstrating a compelling justification.” In particular, Defendants proved that the broad relief sought in the custodian action presented an “existential crisis” for UIP. The Court also relied on the fact that the stock sale was consistent with the company’s previously devised succession plan. Accordingly, judgment was entered once again for Defendants.

Dispute Resolution

The United States Supreme Court Resolves Circuit Split Over the Question of Whether Prejudice Is Relevant in Deciding Whether or Not There Is a Waiver

By Leslie A. Berkoff, Partner at Moritt Hock & Hamroff LLP, Chair of Dispute Resolution Department

In a recent unanimous opinion, the U.S. Supreme Court held in Morgan v. Sundance, Inc., No. 21-328, 2022 WL 1611788 (U.S. May 23, 2022) that employers who do not act promptly to invoke an arbitration clause may be held to have waived the right to compel arbitration. This decision resolves a circuit court split on whether a party opposing a delayed motion to compel arbitration had to show that it had been prejudiced by such delay to support an argument of waiver. The current decision is a significant departure from a lengthy historical set of pro-arbitration rulings by the Supreme Court over recent years and has important implications for those who might have relied upon precedent in determining when to advance their contractual rights in this regard. In issuing this decision, the Court specifically recognized that despite the clear policy underpinning the Federal Arbitration Act (FAA) favoring arbitration, federal courts may not simply interpret arbitration agreements with an unfettered bias towards arbitration.

As a general matter, when an action is commenced in state or federal court, a defendant has the right to file a motion to stay the litigation and seek to compel arbitration if the underlying dispute is governed by a contractual arbitration provision pursuant to Sections 3 & 4 of the FAA. However, the question arises as to when to bring that motion, and until this decision, even if there has been a significant delay in bringing such a motion, the majority of the circuit courts have often granted the motion as long as there has been no prejudice to the nonmoving party. In the case below, the Eighth Circuit had held that whether a defendant, which had waited eight months into the litigation to make its motion to compel arbitration, had waived its right was dependent upon whether it knew of its right, acted inconsistently with its right, and (most important for this analysis) the other party was prejudiced by such action. The lower decisions both found that while the first two prongs were met, the third was not—that there was no prejudice to the other side, and as such, the motion was granted and the arbitration was allowed to go forward. Notably, nine circuit courts had adopted a similar pattern of analysis. The Supreme Court granted certiorari to resolve the circuit split.

The issue presented to the Supreme Court was whether federal courts could essentially develop “‘arbitration-specific’” rules for addressing specific questions, such as those rules concerning waiver, given the long-held policy considerations of the FAA’s favoring arbitration. Sundance, 2022 WL 1611788 at *3 (quoting Moses H. Cone Memorial Hospital v. Mercury Constr. Corp., 460 U.S. 1, 24 (1983)). The Supreme Court held that federal courts simply cannot do so. Sundance, 2022 WL 1611788 at *1. The Supreme Court determined that outside of the arbitration context, prejudice is not typically considered when determining whether a party has waived its right. While the Supreme Court recognized an overarching federal policy favoring arbitration was intended to combat the judicial history of refusing to enforce arbitration agreements, it noted that this policy was only intended to “‘make arbitration agreements as enforceable as other contracts, but not more so.’” Sundance, 2022 WL 1611788 at *4 (quoting Prima Paint Corp. v. Flood & Conklin Mfg. Co., 388 U.S. 395, 404, n. 12 (1967)). Therefore, federal courts are not to use this policy as carte blanche to create “special, arbitration-preferring procedural rules.” Sundance, 2022 WL 1611788 at *4.

The takeaway from this decision is clear: parties should not wait to file motions to compel arbitration based upon prior caselaw. If you believe that a right exists, you should advance that right as early as practicable to avoid having that motion denied based upon an argument of waiver.

U.S. Supreme Court Limits the Right to Discovery Under Section 1782 of Title 28

By Tina M. Kassangana, third-year corporate associate, Moritt Hock & Hamroff LLP

On June 13, 2022, the Supreme Court issued a unanimous opinion holding that neither private international commercial arbitration nor ad hoc arbitration initiated pursuant to a treaty amongst nations qualified as a “foreign or international tribunal” under Section 1782 of Title 28 of the United States Code for purposes of authorizing discovery. In its consolidated ruling of ZF Automotive U.S., Inc. v. Luxshare, Ltd and Alixpartners LLP v. The Fund for Protection of Investors’ Rights in Foreign States, the Court held that only a governmental or intergovernmental body constituted a “foreign or international tribunal” that had the authority to permit discovery under Section 1782 of Title 28. The Court determined that a “foreign tribunal” more naturally refers to a tribunal that “exercises governmental authority conferred by a single nation” whereas “international tribunal” refers to a tribunal that “exercises governmental authority conferred by two or more nations.” Id. The Court noted that in ZF Automotive, DIS was a private, non-governmental commercial arbitration center. In Alixpartners, the parties initiated arbitration proceedings pursuant to a bilateral investment treaty executed by two sovereign nations; however, the Court observed that the treaty did not create the tribunal itself nor did the treaty associate the tribunal with either the Russian or Lithuanian government. Since neither ZF Automotive nor Alixpartners conferred governmental authority to their respective tribunals, the parties could not seek federal assistance under Section 1782. The Court further explained that a key purpose of Section 1782 is to achieve comity. Allowing federal courts to assist foreign governmental bodies promotes and respects foreign governments and enables the United States to receive reciprocal assistance within those nations. The Court did not view lending “resources of a district court” to private, international disputes as furthering the comity of nations.

The Court’s ruling is beneficial for cost-conscious and confidentiality-focused parties. Expansive discovery would rapidly increase arbitration costs, and public federal filings could deter potential private, international parties. It is worth noting, however, the Court did not limit an arbitrator’s ability to request discovery directly from the parties. Moreover, the Court’s ruling did not address whether tribunals formed pursuant to bilateral investment treaty arbitrations initiated through the International Centre for Settlement of Investment Disputes (ICSID) would be precluded from discovery assistance under Section 1782.