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Business Law Today

July 2023

July 2023 in Brief: Business Litigation & Dispute Resolution

July 2023 in Brief: Business Litigation & Dispute Resolution
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Business Litigation

Delaware Supreme Court Declines to Enforce a “Conclusive and Binding” Charter Provision That Would Immunize Breaches of the Fiduciary Duty of Loyalty

By K. Tyler O'Connell of Morris James LLP

In CCSB Financial Corp. v. Totta, 2023 WL 4628822 (Del. Jul. 19, 2023), the Delaware Supreme Court affirmed the Court of Chancery’s post-trial decision that a so-called “Conclusive and Binding Provision” in a certificate of incorporation—providing that any “good faith” board decisions applying a stockholder voting limitation shall be “conclusive and binding upon the Corporation and its stockholders”—could not prevent judicial review for directors’ compliance with the fiduciary duty of loyalty. Having so found, the Court of Chancery ruled that the incumbent directors misapplied the voting limitation, and that they wrongfully refused to count votes that would have resulted in the election of insurgent directors.

In affirming the decision, the Supreme Court explained: “[w]hen the Court of Chancery reviews a claim in this context, the court, as it did here, performs a two-step review – first, it tests the legality of the board’s action under the charter, and second, it applies enhanced judicial review under established standards. CCSB argues in essence that the Conclusive and Binding Provision eliminates the first step, and requires business judgment review for the second step.” Such a provision was inconsistent with Section 102(b)(7) of the Delaware General Corporation Law (DGCL), which the Court reasoned “specifically prohibits a charter provision that directly or indirectly limits director liability for breaches of the duty of loyalty.” The Supreme Court reasoned that such a provision could be included in a Delaware limited liability company agreement or a Delaware limited partnership agreement, but it could not be included in a Delaware certificate of incorporation. Thus, the incumbent directors’ attempt to use it “to exculpate themselves from a breach of the duty of loyalty” was “prohibited by Delaware statute and public policy.” The Supreme Court accordingly affirmed the Court of Chancery’s decision that the insurgent slate prevailed in the election. It also affirmed that the insurgents’ efforts in obtaining a judicial construction of the provision comprised a corporate benefit entitling them to reimbursement of their attorneys’ fees and expenses.

Delaware Court of Chancery Holds Company in Contempt for Failure to Pay Advancement

By K. Tyler O’Connell of Morris James LLP

Directors, officers, and other members of management often have the right under a company’s organizational documents to have defense costs advanced during the pendency of a covered case, investigation, or other proceeding. If the company does not comply, the person with advancement rights can initiate a summary advancement proceeding in the Delaware Court of Chancery to obtain a dourt order requiring payment by a date certain. In Gandhi-Kapoor v. Hone Capital LLC, 2023 WL 4628782 (Del. Ch. Jun. 19, 2023), the Court of Chancery held that a failure to pay as required is punishable as contempt.

Here, the advancement petitioner was the former chief financial officer and a partner of a venture capital fund. Her employment was terminated for disputed reasons, and the fund sued her. Although the Court of Chancery ordered mandatory advancement, the company did not pay, forcing her to bring a motion for contempt. The Court reasoned that, although money judgments generally are not enforceable by contempt, advancement orders are different. They are interim fee awards intended to be paid on an ongoing basis during the life of the advancement proceeding. Moreover, the Court of Chancery has broad equitable discretion to shape relief when there otherwise was an inadequate remedy at law. A company’s failure to provide mandatory advancement may threaten irreparable harm—potential prejudice in the underlying proceeding that cannot readily be undone. In granting sanctions, the Court exercised its discretion and imposed the least possible sanction that it believed may ensure compliance. The Court denied the petitioner’s request for a limited purpose receiver, reasoning that, while that relief could be available, it was not appropriate in the presently known circumstances. The Court imposed a $1,000 per day fine, an amount that the Court held appropriately exceeded the returns per day the venture capital firm might expect to realize on the withheld amounts. The Court reasoned that additional contempt sanctions may be imposed in the future if necessary to enforce compliance.

Dispute Resolution

The Supreme Court Finds Foreign Award Creditor Can Bring Claims under RICO to Enforce Award

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

On June 22, 2023, the Supreme Court issued a 6–3 opinion in Yegiazaryan v. Smagin, holding that a foreign award creditor may bring claims under the Racketeer Influenced and Corrupt Organizations Act (“RICO”) related to the enforcement of an arbitral award rendered in the United States by adopting a “context-specific” test. In issuing this decision, the Court resolved a split in the Circuits concerning how to determine the location of an injury associated with a judgment enforcing an arbitration award for purposes of a RICO claim. Previously, the Seventh Circuit had applied a residency test concluding that the injury occurred where a plaintiff resided, whereas the Ninth Circuit found that injury occurred where the Court entering an award was located.

In applying this approach to the Smagin case, the Supreme Court found that the facts supported a finding that the injury suffered by the foreign plaintiff related to where the interference with the enforcement of the foreign arbitral award occurred, which was in the United States, and that a RICO claim could be asserted in the United States.

Smagin and Yegiazaryan were parties to an arbitration proceeding in London that ended with the entry of a multimillion-dollar arbitral award in favor of Smagin. Both of these individuals were Russian nationals, and the real estate joint venture underlying the arbitral dispute concerned property located in Russia; however, the defendant Yegiazaryan lived in California. Smagin sought to enforce his award in a California federal court, which entered the award. Thereafter, in an effort to evade enforcement of the judgment, Yegiazaryan created multiple shell companies and set up complex transactions to conceal his assets. Smagin ultimately filed a civil RICO suit alleging that the defendant had conspired with a number of entities, including law firms and banks, to commit inter alia wire fraud as part of a RICO scheme. In opposition, Yegiazaryan argued that the claimant could not establish that he had suffered a “domestic injury” but rather the injury occurred in Russia because he was a Russian citizen. While the district court dismissed the case, the Ninth Circuit reversed, finding that Smagin’s harm had been suffered in California because his right to enforce a California judgment was impeded and the conspiracy occurred within California.

The Supreme Court adopted the context-specific test and found that courts should assess “the nature of the alleged injury, the racketeering activity that directly caused it, and the injurious aims and effects of that activity” in order to determine if the injury arose in the United States. The Court found that in utilizing this approach, Smagin had clearly established a domestic injury because the racketeering took place in California and the harm was suffered in California.

The decision expands the avenues for foreign award creditors to enforce arbitral awards in the United States where the obligor has taken steps to evade its obligations. The Supreme Court’s ruling should also be seen as a warning to professionals and lending institutions who could be viewed as assisting clients in evading arbitral awards and judgments.

Supreme Court Finds Underlying District Court Action Is Automatically Stayed Pending Interlocutory Appeal of a Denial of a Motion to Compel Arbitration

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

On June 23, 2023, the U.S. Supreme Court issued a long-awaited ruling in Coinbase v. Bielski, deciding in a 5–4 decision that district court litigation is automatically stayed pending an appeal of a decision denying a motion to compel arbitration. This decision resolves a circuit split between the Third, Fourth, Seventh, Tenth, Eleventh, and D.C. Circuits—which held that the denial of a motion to compel divested the district court of jurisdiction, automatically staying proceedings—and the Second, Fifth, and Ninth Circuits, which had left the decision to stay to the discretion of the district court judge.

In the case below, Coinbase had filed a motion to compel arbitration based on an underlying agreement, but the district court denied the motion. Coinbase then filed an interlocutory appeal to the Ninth Circuit under Section 16(a) of the Federal Arbitration Act (“FAA”) and simultaneously moved to stay the proceedings before the district court pending resolution of the appeal. Both the district court and the Ninth Circuit denied Coinbase’s motion to stay. The Supreme Court determined that Section 16(a) of the FAA, which provides that a party seeking arbitration may file an immediate interlocutory appeal when a district court denies a motion to compel arbitration, had been enacted against “a clear background principle” that an appeal “divests the district court of its control over those aspects of the case involved in the appeal.” Id. The Court relied in part on an earlier decision in Griggs v. Provident Consumer Discount Co., 459 U.S. 56 (1982), wherein the Court found that when the question on appeal is whether the case belongs in arbitration and the entire case is “involved in the appeal,” it should not proceed pending appellate resolution. The Court was not persuaded that the absence of an explicit stay requirement in the FAA indicated other Congressional intent or that ordinary discretionary stay factors would adequately protect parties’ rights. The Court rejected arguments that questions of arbitrability are severable from the merits of underlying disputes. The Court reasoned that if the underlying proceedings were not stayed, certain benefits of arbitration (i.e., efficiency and cost reduction) would be lost.

With respect to this last point, the dissenting Justices criticized the majority for its cursory discussion of severability and found the majority’s reliance on Griggs to be overly expansive and misplaced, as no case had imposed a mandatory general stay of proceedings pending an interlocutory appeal at the time Section 16(a) was enacted. The dissent expressed concern that the majority’s rule would prevent district courts from rendering fact-specific decisions utilizing ordinary discretionary stay factors.

Going forward, the change for those practicing in the minority courts will be significant. There is also an economic and strategic impact for those determining whether to appeal a denial of a motion, as they are no longer spending dollars in both courts.