Many view the period between Thanksgiving and Jan. 1 as one of the busiest times of year, and the Delaware courts were certainly no exception in 2017. Since Thanksgiving, the Delaware Court of Chancery, the Superior Court, the Supreme Court and even the federal District of Delaware have issued a flurry of opinions impacting the landscape in appraisal, the MFW doctrine, the Corwin doctrine, contract interpretation, director compensation and judicial appointments. Below are some highlights.

Appraisal: The Delaware Supreme Court Continues Its General Support for
Deal Price Equaling “Fair Value.”

On Dec. 14, 2017, in Dell v. Magnetar Global Even Driven Master Fund—A.3d—2017 Del. LEXIS 518 (Del. Dec. 14, 2017), the Delaware Supreme Court reversed the Court of Chancery's decision to accord no weight to deal price and rely exclusively on its own discounted cash flow analysis in finding fair value to be more than 25 percent above the deal price. The Delaware Supreme Court found that the trial court's decision to give no weight to the deal price “did not follow from the court's key factual findings and from relevant, accepted financial principles.” While stating that “there is no requirement that the trial court assign some mathematical weight to the deal price” and no rule that the deal price “should always be granted some weight,” the Delaware Supreme Court found that the record below “suggested that the deal price deserved heavy, if not dispositive, weight.”

The Delaware Supreme Court analyzed separately each of the Court of Chancery's three primary premises for not according weight to the deal price. First, the Delaware Supreme Court found there was “no rational, factual basis” for the trial court's conclusion that the market price for Dell reflected a “valuation gap” caused by “'investor myopia'” because the record showed that market participants “scrutinized Dell's long-range outlook” and were “capable of accounting for Dell's recent mergers and acquisitions and their prospects,” and the conclusion “ignored the efficient market hypothesis long endorsed by this court.” Second, the Delaware Supreme Court rejected the conclusion that the deal price should be accorded no weight because there were no strategic bidders in the sale process and financial sponsors underbid per se because of internal hurdle rates. Continuing its critique from DFC Global v. Muirfield Value Partners, L.P.—A.3d—2017 Del. LEXIS 324 (Del. Aug. 1, 2017), the Delaware Supreme Court found the concept of a “'private equity carve out' stood on especially shaky footing where other objective indicia suggested the deal price was a fair price” and noted that “'all disciplined buyers, both strategic and financial, have internal rates of return that they expect in exchange for taking on the large risk of a merger, or for that matter, any sizeable investment of its capital.'” Finally, the Delaware Supreme Court rejected the argument that the MBO structure in the Dell sales process rendered the resulting deal price of negligible probative value. It was not enough for the trial court to claim that Dell was “large and complex” and bidders inherently suffered from the concept of a “winner's curse.” While noting that there are instances where an MBO-focused process could be a concern, the Delaware Supreme Court noted that the record below did not yield a conclusion that management was inherent to Dell's value or that management was not forthcoming with any time or information necessary for bidders to assess the company's value.

The Delaware Supreme Court also noted that, “in addition to the relatively sound economic reasons, there are also important policy reasons supporting” deference to the deal price obtained in the Dell sale process: “if the reward for adopting many mechanisms designed to minimize conflict and ensure stockholders obtain the highest possible value is to risk the court adding a premium to the deal price based on a DCF analysis, then the incentives to adopt best practices will be greatly reduced.”

While noting throughout the strong evidence in favor of the deal price and the important policy goals of encouraging robust sale processes, the Delaware Supreme Court did not mandate that the trial court order deal price on remand, stating:

“Despite the sound economic and policy reasons supporting the use of the deal price as the fair value award on remand, we will not give in to the temptation to dictate that result. That said, we give the vice chancellor the discretion on remand to enter judgment at the deal price if he so chooses, with no further proceedings. If he decides to follow another route, the outcome should adhere to our rulings in this opinion.”

Dell is in line with other recent decisions from the Delaware courts, stating that in situations with robust sale processes and no structural impediments, the court viewed deal price as the most persuasive factor in determining fair price. Whether this trend continues or these decisions impact the practice of so-called “appraisal arbitrage” remains to be seen.

MFW: Business Judgment Protections Expand Beyond the Merger Context.

The expansion of the doctrine articulated by the Delaware Supreme Court in Kahn v. M&F Worldwide, 88 A.3d 635 (2014) (MFW), for affording business judgment rule protection to transactions traditionally viewed ab initio under entire fairness has been steady and well-documented. While MFW dealt with a controlling stockholder squeeze-out merger, the principles articulated in that decision have been applied to tender offers and controlled company sales to third parties. In IRA Trust FBO Bobbie Ahmed v. Crane, Consol. C.A. No. 12742-CB, 2017 Del. Ch. LEXIS 843 (Del. Ch. Dec. 11, 2017), the Delaware Court of Chancery applied the principles of MFW outside the merger context and granted a motion to dismiss challenges to the stock reclassification. Under the allegations of the complaint, the controlling stockholder of NRG Yield was in danger of being diluted below majority ownership as a result of NRG Yield's continued issuance of shares as currency to effectuate strategic goals. When the controller proposed a reclassification that would allow it to maintain its controller status, NRG Yield formed a special committee and negotiated with the controller over the terms of a reclassification, which was subsequently approved by a majority of the minority shares.

Recognizing the expansion of the MFW doctrine beyond the merger context, the Court of Chancery noted that applying the principles broadly to all cases where entire fairness review is presumed “would parallel” the evolution of the Delaware Supreme Court's earlier seminal opinion Kahn v. Lynch Communications System, 638 A.2d 1110 (Del. 1994), which held that if only one of the twin procedural protections later articulated in MFW (approval by a fully empowered special committee and approval by a fully informed, uncoerced majority of the minority) were present, then entire fairness still applies but the burden is shifted to plaintiffs to prove the challenged transaction was not entirely fair.

Crane suggests that the Court of Chancery is willing to extend MFW principles and allow the possibility of business judgment protection to any case where a controller receives a unique benefit. As a result, any further expansion of MFW will continue to be closely watched in 2018.

Corwin: Denial of Protection Does Not Alleviate Need to Adequately Plead Claim;
Corwin Defense Improper in Section 220 Books-And-Records Action.

The reach of the Corwin doctrine—which accords business judgment rule protection for fiduciary decisions (absent a conflicted controller) approved by a fully informed, uncoerced stockholder vote so long as the transaction is not presumptively reviewed under entire fairness—has been a closely watched topic since the Delaware Supreme Court decision in 2015, see Corwin v. KKR Financial Holdings, 125 A.3d 204 (Del. 2015). Less closely watched is what happens when Corwin is not applicable because there are well-pleaded allegations that the stockholder vote was tainted. The Delaware Court of Chancery recently addressed this issue in Van Der Fluit v. Yates, C.A. No. 12553-VCMR, 2017 Del. Ch. LEXIS 829 (Del. Ch. Nov. 30, 2017).

In Van Der Fluit, the Court of Chancery found that stockholders of Opower Inc. “overwhelmingly” tendered into an offer from Oracle Corp. to acquire Opower. However, the Court of Chancery also found that well-pleaded disclosure claims precluded the application of Corwin because the vote, on the allegations presented, was not fully informed. But the court's analysis did not end there. Because Opower possessed an exculpatory provision in its charter, plaintiff still was required to plead a nonexculpated claim to survive a motion to dismiss. Thus, after deciding the application of Corwin, the Court of Chancery then began a more “traditional” analysis of the allegations in the complaint and found that each of the allegations failed to state a nonexculpated claim. As a result, the complaint was dismissed.

In Lavin v. West Corp., C.A. No. 2017-0547-JRS, 2017 Del. Ch. LEXIS 866 (Del. Ch. Dec. 29, 2017), the Court of Chancery ruled “as a matter of law” that Corwin is not available as a defense to a stockholder's request for books and records under 8 Del. C. Section 220 because it “would invite defendants improperly to draw the court into adjudicating merits defenses to potential underlying claims.” The plaintiff sought books and records to investigate potential wrongdoing related to an agreed merger between West Corp. and a third party. In response to multiple lawsuits challenging the disclosures made by West in connection with the merger, West filed a supplemental proxy statement mooting the claims brought in other actions, but not the disclosure claims asserted by the plaintiff in Lavin. Roughly 86 percent of the company's shares voted and approved the merger.

The Court of Chancery found premature West's argument that the court could consider a Corwin defense within the “limited scope” of a Section 220 action and noted that “it would be naïve to believe, in most instances, that the stockholder plaintiff will not face significant challenges to meet her pleading burden in anticipation of a Corwin defense if all she has in hand to prepare her complaint are the public filings of the company whose board of directors she proposes to sue.” Distinguishing Southeastern Pennsylvania Transportation Authority v. AbbVie, C.A. Nos. 10374-VCG, 10408-VCG, 2015 Del. Ch. LEXIS 110 (Del. Ch. Apr. 15, 2015), which refused the plaintiff's books and records demand because the plaintiff had stated that its sole purpose was to bring derivative claims that would be exculpated under 8 Del. C. Section 102(b)(7), the Court of Chancery stated that the claim in AbbVie was not “'justiciable'” and “it was clear to the court that no amount of additional information would aid the stockholder in pleading or prosecuting the contemplated plenary action.”

After finding that it could not consider the Corwin defense, the Court of Chancery found that, “with the low Section 220 evidentiary threshold very much in my mind,” the plaintiff provided “'some evidence' that West's directors and officers may have breached their Revlon duties, possibly in bad faith,” and had stated a proper purpose of wanting to investigate director independence. However, the Court of Chancery reduced the categories of documents for production from the 13 demanded to five, noting that, “when measured against the Proxy, the documents [ordered for production] may also offer some insight into whether the stockholder vote was fully informed as Lavin attempts to meet his pleading burden in anticipation of a Corwin defense.”

Contracts: Delaware Courts Issue Contract 'Primer' and Hold That Anti-Reliance Provisions Do Not Bar 'Intra-Contractual' Fraud Claim.

The application of contractual canons and the workings of anti-reliance provisions also have featured prominently over the last several weeks. In ITG Brands v. Reynolds American, C.A. No. 2017-0129-AGB, 2017 Del. Ch. LEXIS 819 (Del. Ch. Nov. 30, 2017), the Court of Chancery engaged in a detailed discussion of the language and construction of the contract at issue, ultimately finding that the “plain language” of the contract controlled. While the specific provisions at issue may not be helpful for many practitioners, the analysis included reference to and discussion of both well-known contractual canons and lesser-explored tenets of contract construction, such as the interplay between independent and dependent clauses and the “'nearest-reasonable-reference-canon.'”

In Novipax Holdings v. Sealed Air, C.A. No. N17C-03-1682 EMD CCLD, 2017 Del. Super. LEXIS 605 (Del. Super. Ct. Nov. 28, 2017), the Delaware Superior Court denied a motion to dismiss fraudulent inducement claims related to the completed sale of one of Sealed Air's businesses. The Superior Court rejected arguments that the mutual anti-reliance provision in the contract barred what the court deemed “intra-contractual” fraud claims. After finding that these fraud claims survived, the Superior Court sustained both the fraud and substantively identical breach of contract claims because the complaint sought rescission and rescissory damages for the fraud claim. Thus, the fraud claim was not simply “bootstrapped” to the breach of contract claim.

Director Compensation: Delaware Supreme Court Weighs In On Claims Challenging Discretionary Director Equity Compensation.

Ahead of proxy season, the Delaware Supreme Court issued an opinion for the first time in more than 50 years on ratification in the context of director self-compensation. This opinion, which eliminates the defense of ratification for director equity incentive plans that contain discretionary elements, has broad and immediate implications for director compensation and likely will be a hot topic in board rooms ahead of this year's annual meetings.

In In re Investors Bancorp Stockholder Litigation, C.A. No. 12327-VCS, 2017 Del. Ch. LEXIS 53, at *23-25 (Del. Ch. Apr. 5, 2017), the Court of Chancery, relying on its prior decisions, dismissed challenges to allegedly outsized grants of equity to directors because stockholders had approved the underlying equity incentive plan (the EIP) and the court found that the EIP contained “meaningful, specific limits on awards to all director beneficiaries.” The Delaware Supreme Court reversed. After canvassing the development of the law in the lower court over the last 50 years, the Delaware Supreme Court summarized:

“As ratification has evolved for stockholder-approved equity incentive plans, the courts have recognized the defense in three situations—when stockholders approved the specific director awards; when the plan was self-executing, meaning the directors had no discretion when making the awards; or when directors exercised discretion and determined the amounts and terms of the awards after stockholder approval. The first two scenarios present no real problems. When stockholders know precisely what they are approving, ratification will generally apply. The rub comes, however, in the third scenario, when directors retain discretion to make awards under the general parameters of equity incentive plans, In re Investors Bancorp Stockholder Litigation—A.3d—2017 Del. LEXIS 517, at *24 (Del. Dec. 13, revised Dec. 19, 2017).”

Without explicitly overruling the prior Court of Chancery cases, the Delaware Supreme Court stated that, in the third scenario, “when it comes to the discretion directors exercise following stockholder approval of an equity incentive plan, ratification cannot be used to foreclose the Court of Chancery from reviewing those further discretionary actions when a breach of fiduciary duty claim has been properly alleged.”

After clearing away the ratification defense, the Delaware Supreme Court reaffirmed that director compensation grants were “self-interested decisions” subject to presumptive entire fairness review and that plaintiff had pled sufficient facts to overcome the demand requirement of Court of Chancery Rule 23.1 and to meet its threshold burden to show unfairness even when entire fairness applies ab initio.

Finally, the Delaware Supreme Court rejected defendants' argument that demand was not futile under Court of Chancery Rule 23.1 for executive director compensation (which was different than outside director equity compensation) because a majority of the board was not composed of executive directors and thus was not “interested” in those awards. Noting that all director grants were made at the same time, the Supreme Court rejected that argument because “it is implausible to us that the non-employee directors could independently consider a demand when to do so would require those directors to call into question the grants they made to themselves.”

The impact of this decision will be something to watch closely in 2018.

Judicial Appointments: Delaware Federal Court Strikes Down Political Balance Requirement As Unconstitutional.

In Adams v. Carney, C.A. No. 17-181-MPT, 2017 U.S. Dist. LEXIS 200304 (D. Del. Dec. 6, 2017), which is currently on appeal, a federal magistrate judge struck down a provision in the Delaware Constitution prohibiting one political party from holding more than a “'bare majority'” of the total seats in the Delaware Supreme Court, the Delaware Court of Chancery and the Delaware Superior Court (together, the Delaware courts), and requiring the remaining seats in the Delaware courts to be populated with members of the “'other major political party.'” The plaintiff, an independent, alleged he was denied the opportunity to apply for vacant seats on the Delaware courts because he was not affiliated with one of the two major political parties.

The magistrate judge found this so-called “political balance requirement” unconstitutional, noting that judicial positions in Delaware are not exempt from the prohibition under the First Amendment from requiring political affiliation for governmental employment because they are not “policymaking positions.” Quoting the U.S. Court of Appeals for the Third Circuit, the district court stated that “a difference in political affiliation is only a proper factor in making employee decisions if it is highly likely 'to cause an official to be ineffective in carrying out the duties and responsibilities of the office.'” After examining the relevant factors considered by federal courts and the requirements placed on Delaware judges by the state itself, the district court concluded that “the judiciary, although a very important role, is not a policy-making position.” Thus, it concluded, “the Constitution of the state of Delaware violates the First Amendment by placing a restriction on governmental employment based on political affiliation in the Delaware judiciary.”

Takeaways

The recent flurry of opinions provides many helpful takeaways for companies and practitioners.

• Opinions in appraisal, MFW and Corwin cases continue to promote the use of robust sale processes with strong structural protections by according strong probative value to the results of, and deferential review to, such processes. However, one recent decision from the Court of Chancery has held that a Corwin defense is not available in a statutory books and records action.

• Delaware courts continue to hold sophisticated parties to the plain language of their agreements, and the court will avoid readings of contractual provisions that require strained grammatical arguments.

• Directors of Delaware corporations should examine their self-compensation plans in light of recent rulings.

• The possibility exists that the future makeup of the Delaware judiciary could become heavy with members from one political party. However, any such concern is counterbalanced by the express mandate in the Delaware Judges' Code of Judicial Conduct that members of the Delaware judiciary not be “swayed by partisan interest.”

Arthur R. Bookout, an associate with Skadden, Arps, Slate, Meagher & Flom, represents directors, officers and corporations in litigation involving corporate governance and federal securities matters. This article reflects the views of the author and not the firm or its clients.