August 16, 2012 Articles

Chancery Arbitrations after Year One: Annotated New Form

After a year of hands-on experience with binding private arbitration in the Court of Chancery, a second-generation dispute resolution form has evolved

by Greg Varallo, Rich Rollo, and John Mark Zeberkiewic

On January 5, 2010, the Delaware Court of Chancery adopted a set of rules providing for arbitration in the court, giving life to a recently adopted statute permitting Delaware's Chancery judges to act as private arbitrators. See 10 Del. Code § 349 (adopted Apr. 2, 2009); Del. Ch. Ct. Rules 96–98 (adopted Jan. 5, 2010). See also Gregory P. Williams, Gregory V. Varallo, Jillian Remming & A. Jacob Werrett, "Arbitration in the Delaware Court of Chancery," Insights, July 2011, at 1. Practitioners in the court now have the benefit of having worked through some of the initial "growing pains" associated with this new forum. With at least five arbitrations having moved through the court's arbitration docket since the first such proceeding was filed in March 2011, we are privileged to have been involved in each one, serving as lead counsel in most. Having tried or argued most of these early matters, we have attempted to refine our firm's form arbitration provision to reflect our direct experiences. While the specifics of any arbitration in Chancery are confidential, the updated form [PDF] with annotations reflects our experiences and flags issues that may arise in any arbitration proceeding and that, accordingly, parties should consider addressing when negotiating the specific terms of any agreement to arbitrate in Chancery.

Although the form is designed to be included in a merger agreement or other significant transaction agreement between sophisticated commercial parties, its principal terms may be modified and included in a stand-alone agreement that commercial parties enter into after a dispute has arisen over a preexisting agreement or other instrument.

The statute allowing such arbitrations provides for appointment of a chancellor or vice chancellor of the court as arbitrator where (1) the parties consent to arbitration, (2) at least one of the parties is a business entity, (3) one of the parties is either formed in Delaware or maintains its principal place of business there, (4) neither party is a consumer, and (5) the amount in controversy is no less than $1 million. See 10 Del. Code§§ 349, 347(a) & (b). The arbitrations are confidential, id.; Del. Ch. Ct. R. 97(a)(4) & 98(b), and the rules of the court contemplate disposition of such matters within 90 days of filing. See Del. Ch. Ct. R. 97(e). Appeals from the arbitration are subject to waiver or, if not waived, go directly to the Delaware Supreme Court. See 10 Del. Code§ 349(c). Most importantly, the parties have an almost unlimited ability to "customize" the process by agreeing in advance (or at the time the dispute is presented) to provisions they deem appropriate to streamline and make more efficient the resolution of the dispute. Thus, rather than litigate disputes over earn-out clauses, escrow arrangements, or alleged breaches of representations and warranties, or even whether a "material adverse event" has occurred, parties may, by mutual consent, have those and countless other matters resolved through a confidential, prompt, and potentially non-appealable alternative dispute resolution mechanism. Unlike the typical alternative dispute resolution forum, however, this one is hosted by a sitting judge, appointed specially as arbitrator—someone who makes his or her living making tough decisions, not attempting to compromise or "split the baby," and who, as a member of one of the world's leading courts for business disputes, has substantial expertise in complex corporate and commercial matters. In short, the new arbitration forum offers all of the benefits of litigation in the Court of Chancery, with the added benefit of privacy, an ultra-quick resolution schedule, and the potential to make the resolution final, binding, and non-appealable.

Of course, nothing is ever perfect. Both sides to an agreement have to consent to this alternative dispute resolution mechanism to trigger it. In addition, at least one public interest group, the Delaware Coalition for Open Government, Inc., has brought a constitutional challenge to the process. The group initially filed a complaint in the U.S. District Court for the District of Delaware, Delaware Coalition for Open Government, Inc. v. The Hon. Leo E. Strine, et al., C.A. No.1:11-cv-01015-MAM(D. Del. Jan. 20, 2012), but the judges on that court recused themselves, following which the case was transferred to the U.S. District Court for the Eastern District of Pennsylvania. See Peg Brickley, "Secrecy Puts Judges on Defense in Delaware," Wall St. J., Feb. 21, 2012, at B1.

As the name of this group would suggest, the complaint alleges that the confidentiality provisions of the arbitration statute, as enacted by the rules, "constitute an unlawful deprivation of the public's right of access to trials." See Complaint ¶ 20, Delaware Coal. for Open Gov't, Inc., C.A. No. 1:11-cv-01015-MAM. The group is accordingly seeking a declaration that the arbitration statute and the rules are unconstitutional, a permanent injunction against the named defendants (the sitting chancellor and vice chancellors and the State of Delaware) from conducting any nonpublic proceedings under the statute and the rules, and an order unsealing all documents filed pursuant to the statute and the rules. Id. ¶¶ a, b & c.

Although the case is still pending in federal court, if the statute and the rules were found to be unconstitutional, one potential outcome would be that Delaware maintain a Chancery arbitration regime, albeit one that does not permit the proceedings to remain confidential. Given this possibility, parties may consider including in their arbitration provisions a limited "severability" clause that would provide for the confidentiality mandates to be severed from the provision, with the otherwise valid terms being enforced, or direct that the provisions of any successor statute or rules be applied mutatis mutandis to the maximum extent possible. If the court were no longer conducting arbitration proceedings, the provision would specify that the parties will arbitrate the covered disputes in Wilmington, Delaware, before a former member of the court selected in good faith by mutual agreement of the parties or, if no such member of the court is available, by another qualified arbitrator selected in good faith by the parties. Nevertheless, until and unless the federal courts put a halt to the regime or to any part of it, this new arbitration forum is "open for business."

As the lead author noted in a previous article introducing the new procedure and the court's rules, several companies incorporated first-generation arbitration provisions into public merger agreements and other documents. See Williams et al., supra, at 3–4 (discussing the Teradata Corp. arbitration provision for escrow claims in a public transaction and Global Defense Technology & Systems Inc.'s provision submitting all disputes arising under a public merger agreement to Chancery arbitration). The merger agreement between Skyworks Solutions, Inc., and Advanced Analogic Technologies, Inc., also included a provision requiring disputes between the parties under the agreement to be submitted to arbitration in the Court of Chancery. See Skyworks Solutions, Inc., Registration Statement (Form S-4), at A-57–A-59, § 9.11 (June 16, 2011).

These provisions were crafted before arbitrations were actually held in the court and therefore do not reflect actual experience with the new procedure. Although these provisions are helpful in starting precedents, experience with the procedure suggests that they should no longer be relied upon as "state of the art." Instead, the "second generation" form, which includes provisions arising out of our direct experience with the procedure, should now be used as the starting point for parties considering the possibility of submitting potential disputes to Chancery arbitration.

As noted above, contractual parties have significant flexibility in negotiating the terms under which disputes may be arbitrated through the Chancery arbitration process. To this end, our form provides a solid framework for an agreement to arbitrate in the Court of Chancery and sets forth, in bracketed language, several provisions that the parties may, but need not, include. The commentary in the footnotes explains why parties may find it worthwhile to include such language in a particular setting. The commentary also attempts to explicate many of the material terms of the form provision and the basis for those terms. Like any form, this is one that will continue to evolve over time. Moreover, the parties may wish to further modify or supplement this form, depending on the type of parties involved in the transaction (e.g., private or public; large-, mid- or small-cap), their relation to one another (e.g., arm's-length contractual parties negotiating a one-time transaction or a company and one of its equity holders or lenders), the nature of the potential disputes likely to arise between the parties, and any other factors that may be relevant in the context of a particular transaction or arrangement. Accordingly, we would recommend that you consult with your litigators and Delaware counsel before using it, especially if the need arises in the distant future.

After a full year of hands-on experience with binding private arbitration in the Court of Chancery, a second-generation dispute resolution form has evolved. Consider using this form as a starting place for agreements opting for this important new alternative dispute resolution forum.

Keywords: litigation, commercial, business, Delaware, Court of Chancery, arbitration

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