February 2023 in Brief: Business Litigation & Dispute Resolution

Business Litigation

Lordstown Motors: Applying Section 205 of the Delaware General Corporation Law, the Delaware Court of Chancery Validates Shares Issued Without a Separate Class Vote

By K. Tyler O’Connell of Morris James LLP

Adopted in 2013, 8 Del. C. § 205 permits a corporation to petition the Delaware Court of Chancery to validate corporate actions that are defective for lack of authorization when ratification is not feasible or when a ratification attempt is subject to challenge. Section 205 was enacted to address challenges to the validity of stock issuances, among other problems. In the recent case of In re Lordstown Motors Corp., 2023 WL 2155651 (Del. Ch. Feb. 21, 2023), Vice Chancellor Lori W. Will approved Lordstown Motors’ petition to declare valid shares of stock issued pursuant to an amendment of the certificate of incorporation increasing the number of Class A common shares, which had been adopted without a separate class vote.

In late 2022, the Court of Chancery interpreted a similar certificate of incorporation with Class A and Class B common shares as having separate “classes” rather than “series” of stock, with the result that a separate vote of Class A stockholders was required by 8 Del. C. § 242(b)(2) to increase the authorized number of Class A shares. See Garfield v. Boxed, Inc., 2022 WL 17959766 (Del. Ch. Dec. 27, 2022). Following that decision, Lordstown Motors sought relief under Section 205. The Court of Chancery scheduled an expedited hearing at which any objectors could be heard, and required the company to provide notice through its public filings.

Following the hearing, at which no objectors appeared, the Court issued its opinion validating the stock issuance under Section 205(a)(4), which authorizes the Court to “[d]etermine the validity of any corporate act or transaction and any stock, rights or options to acquire stock[.]” The Court applied certain equitable factors set forth under Section 205(d), reasoning inter alia that (i) any mistake was apparently made in good faith; (ii) validation was appropriate to prevent harm to the corporation and its stockholders, who had relied upon the validity of the shares issued; (iii) no legitimate interests would be harmed by validating the shares; and (iv) ratification under 8 Del. C. § 204 was not feasible due to Class A shares being traded among public stockholders in the intervening years. Accordingly, the Court declared the stock valid, providing certainty as to the corporation’s capital structure.

Delaware Court Enters Default Judgment for Extreme Spoliation

By K. Tyler O’Connell and Joseph C. Leonard of Morris James LLP

Spoliation of evidence can lead to significant litigation sanctions, including adverse inferences, fee-shifting and—in egregious cases—the entry of a default judgment. In this recent case involving intentional spoliation of evidence by a corporation’s founder, owner, and chief executive officer, Chancellor Kathaleen St. J. McCormick, sitting by designation in the Delaware Superior Court’s Complex Commercial Litigation Division, found that a non-party’s spoliation may be imputed to a party, and that entry of a default judgment was appropriate. See BDO USA, LLP v. Everglade Global, Inc., 2023 WL 1371097 (Del. Super. Jan. 31, 2023).

Defendant Everglade Global is a consulting firm founded by former BDO partner Eric Jia-Sobota, whose departure led to a legal battle with BDO. During that litigation, BDO became the target of an online smear campaign. Jia-Sobota claimed to have been contacted by an anonymous party online, to whom he claimed to have provided information used in the smear campaign. BDO brought suit for defamation.

Everglade initiated an internal investigation, enlisting an eDiscovery vendor to collect from Jia-Sobota’s devices. The vendor found that a program had been used to wipe data from the devices, including browsing history. As such, it was forced to state the investigation was inconclusive, and it resisted efforts by Jia-Sobota to report differently. Everglade also engaged in other obstructive behavior in discovery, and it refused to engage further with BDO, claiming it had fully satisfied all obligations. When the Court appointed a Special Discovery Master, the extent of the spoliation was revealed, including (i) the use of a “cleaner” program to wipe data, (ii) the destruction of thumb drives, (iii) the deletion of OneDrive data, and (iv) the factory reset of seven laptops at issue. As a result, BDO was deprived of discovery from the potential sources of direct evidence of Jia-Sobota’s wrongdoing.

In response to BDO’s request for a default judgment, Everglade acknowledged the intentional spoliation by Jia-Sobota, but argued that it was not responsible for his behavior. The Court sided with BDO, noting that the requirements of respondeat superior liability were satisfied, and that there also are policy reasons to hold corporations accountable when a CEO destroys evidence. The Court also found that the egregious spoliation and the obstructive conduct of Everglade’s counsel warranted fee-shifting for the sanctions motion and prior discovery practice needed to uncover the spoliation.

Dispute Resolution

New York Creates Alternative Means for Discovery in Light of Supreme Court’s Narrowing of 28 U.S.C. 1782

By Leslie Ann Berkoff, Partner and Chair of Dispute Resolution Department, Moritt Hock & Hamroff LLP

As discussed in a prior month-in-brief, the U.S. Supreme Court this past summer in ZF Automotive US, Inc. v. Luxshare, Ltd., Case No. 21-401, has narrowed the scope of 28 U.S.C. § 1782 (“Section 1782”) by holding that “only a governmental or intergovernmental adjudicative body” is a “foreign or international tribunal” under Section 1782 and that Section 1782 does not apply to private arbitration. However, in its decision the Court did not detail whether arbitral tribunals constituted under the Convention on the Settlement of Investment Disputes between States and Nationals of Other States (ICSID tribunals) qualified as “foreign or international tribunals” under Section 1782.

In some recent decisions flowing from the Eastern and Southern Districts of New York, federal courts have further limited the use of Section 1782, finding that ICSID tribunals that were established to resolve investor-state arbitrations did not qualify as “foreign or international tribunals” under Section 1782. See In re Webuild, Case No. 22 MC 140 (LAK) (S.D.N.Y. Dec. 19, 2022) and In re Alpene, Case No. 21 MC 2547 (MKB)(RML) (E.D.N.Y. Oct. 27, 2022). These decisions have turned on a finding that there was no material difference between ICSID tribunals and the arbitration tribunal that had been the subject of the ZF Automotive decision and which had been convened in accordance with the UNCITRAL Rules.

In the face of the foregoing decisions restricting the application of Section 1782 and precluding parties in a non-governmental or non-intergovernmental proceeding from seeking foreign discovery, there is an option offered under New York’s Civil Practice Law and Rules (CPLR) § 3102 for those seeking to obtain discovery in aid of arbitration from parties who are subject to the jurisdiction of New York courts.

Specifically, CPLR § 3102(c) provides that “[b]efore an action is commenced, disclosure to aid in bringing an action, to preserve information or to aid in arbitration, may be obtained, but only by court order. The court may appoint a referee to take testimony.”

Under CPLR § 3102(c), a party may initiate a special proceeding, which is commenced by a notice of petition or an order to show cause and a petition to obtain discovery in aid of arbitration. As such, parties who seek discovery in aid of arbitration under CPLR § 3102(c) could find this to be a viable alternative when seeking discovery that may no longer be available based upon the narrowing of Section 1782. It is important to be mindful that a party seeking disclosure in aid of arbitration under CPLR § 3102(c) must show extraordinary circumstances and that it is a necessity to obtain such discovery (for example, to aid in arbitration to present a full case to an arbitrator). While this section is not utilized frequently, it is available for the arsenal of a litigator’s tool kit provided, of course, the underlying New York connections and necessity can be established.