Today, the Chief Justice of the Delaware Supreme Court issued Administrative Order No. 9, which extends Delaware’s Judicial Emergency for another 30 days, effective August 7, 2020.  Per the Administrative Order, the Delaware courts will continue to operate under Phase 2.

Citing the “national trend of increasing virus spread, new quarantine requirements by other states, and hotspots within [Delaware]”, the courts will not enter Phase 3 of the Reopening Plan until “medical experts believe it is safe to do so and more information becomes available about the trends in COVID-19 infections and its spread in the United States and Delaware.”

Moreover, per the Administrative Order, all Delaware Courts are authorized, to the greatest extent possible under 10 Del. C. § 2008, to continue to utilize audiovisual devices at their facilities and remotely to conduct proceedings, with the exception of jury trials.  Moreover, the suspension of requirements for sworn affidavits, verifications, oaths or affidavits filed in the Delaware Courts, as set forth under Administrative Order No. 3, remains in effect.

Section 225 of the Delaware General Corporation Law is an important and powerful tool for any shareholder, director or officer seeking to challenge the results of an election of directors of a Delaware corporation, along with the appointment, removal or resignation of any director or officer.

From a procedural perspective, a party seeking such relief may submit a Section 225 petition to the Delaware Court of Chancery.  In such an action, the Delaware Court of Chancery may determine “the validity of any election, appointment, removal or resignation of any director or officer of any corporation, and the right of any person to hold or continue to hold such office.”  Del. C. § 225(a).

A section 225 action is what’s known as a “summary proceeding” in the Delaware Court of Chancery.  Summary proceedings are typically expedited by the Court, and depending on the circumstances of the case, a petitioner can expect a trial on the merits within several months, subject to Court availability.  All trials before the Court of Chancery are bench trials, and opening and closing statements are made through either pre-trial or post-trial submissions.

Further, the Court “may determine the person entitled thereto; and to that end make such order or decree in any such case as may be just and proper, with power to enforce the production of any books, papers and records of the corporation relating to the issue.” Id.  In addition, the Court may also determine the result of any vote of the stockholders upon matters other than the election of directors or officers.

 

In a rare decision pertaining to Section 205 of the DGCL handed down today by the Delaware Court of Chancery, Applied Energetics, Inc. v. Farley, et al., C.A. No. 2018-0489-JTL (Del. Ch. Aug. 3, 2020), Vice Chancellor Laster granted summary judgment in favor of a plaintiff who challenged a defective board action, as result of failing to meet the quorum requirement under the corporation’s bylaws.  However, the Court also ruled that such defective act could be remedied under Section 205 of the Delaware General Corporation Law (“DGCL”).  This decision is an important read for any party seeking to validate an otherwise defective corporate act for failure of authorization.

In Applied Energetics, Plaintiff Applied Energetics, Inc. (the “Company”) sued George Farley, its former director and principal executive officer, and AnneMarieCo, LLC, an entity owned by Farley’s wife and children. The Company asserted claims based on actions Farley took to issue himself twenty-five million shares of common stock and grant himself an annual salary of $150,000 per year. Among other things, Farley brought a counterclaim to validate his actions under Section 205 of the Delaware General Corporation Law (the “DGCL”), 8 Del. C. § 205, among other claims.

The Company moved for partial summary judgment, contending that Farley lacked authority to issue himself twenty-five million shares and grant himself an annual salary of $150,000 per year. At the time Farley took those actions, he was the Company’s sole remaining director. However, the board had three seats.

The Court found that, consistent with the default rule under Section 141(b) of the DGCL, 8 Del. C. § 141(b), the bylaws of the Company mandated that a majority of the total number of directors be present at a meeting to constitute a quorum.

However, the Court denied the Company’s motion for summary judgment as to Farley’s  counterclaim seeking the Court’s validation of the act under Section 205 of the DGCL. The decision notes that the “substantive purpose of [Sections 204 and 205] was “to overrule the existing precedents requiring that defective stock and acts be found void.” Slip op. at 45.

In rejecting the Company’s position that the Court could not rectify the act, Vice Chancellor Laster drew a distinction between the absence of corporation power and a failure of authorization, stating:

[T]he Company contends that because Farley was the sole director on a board with three seats, the corporation lacked the power to take the actions in question. This contention misunderstands the distinction between the absence of corporate power and a failure of authorization. The question of corporate power refers to the ability of the corporation as an entity to engage in a particular act, regardless of what steps may be necessary to properly authorize that act. The question of authorization refers to whether the appropriate combination of intra-corporate actors—viz., the officers, board of directors, or stockholders—took the proper steps to authorize the entity to exercise corporate power in compliance with the requirements of the DGCL and the corporation’s constitutive documents.

Slip op. at 2.

The Court noted that the Company had the corporate power to issue shares and compensate its officers and directors. Farley’s attempts to cause the corporation to take those actions failed because of defects in authorization, not the absence of corporate powers.  Accordingly, the Court found that his acts could be validated under Section 205.

The Court further noted that Section 204(a) of the DGCL, which Vice Chancellor Laster noted refers to as a “keystone” provisions, states that “no defective corporate act or putative stock shall be void or voidable solely as a result of a failure of authorization if ratified as provided in this section or validated by the Court of Chancery in a proceeding brought under § 205 of this title.” 8 Del. C. § 204(a). This provision “legislatively overturns” precedents which held “that stock issued or acts taken in contravention of the DGCL are void and not voidable and thus not susceptible to ratification or validation on equitable grounds or otherwise.” Slip op. at 45 (citations omitted).

This decision is an important read given the dearth of decisions interpreting Sections 204 and 205 of the DGCL.  The 75 page memorandum opinion also provides a helpful guide to the inner workings and legislative history such statutes.

It is well established that when a stockholder of a Delaware corporation makes a books and records demand under Section 220 of the DGCL, the stockholder must state a proper purpose for the requested books and records.  “Valuation of a stockholder’s investment in a corporation, particularly where the corporation is privately held, has long been recognized as a proper purpose under 8 Del. C. § 220.” Thomas & Betts Corp. v. Leviton Mfg. Co., 685 A.2d 702, 713 (Del. Ch. 1995), aff’d, 681 A.2d 1026 (Del. 1996).

An interesting question was posed in a recent Delaware Court of Chancery action as to whether a stockholder must go one step further and explain why the stockholder wants to value such shares.  In the recent written opinion of Woods v. Sahara Enterprises, Inc., C.A. No. 2020-0153-JTL (Del. Ch. July 22, 2020), the Delaware Court of Chancery explained that imposing this additional requirement upon a stockholder is contrary to Delaware law.

In the Woods action, the investments of Sahara Enterprises, Inc. (the “Company”) had underperformed broad market indices, according to the written opinion.  Plaintiff Woods became concerned that the Company was paying its officers and directors, paying highly compensated fund managers, and paying professional consultants to help select the fund managers, yet achieving subpar results.  Plaintiff also sought to value her trust’s shares in the Company.

The Company defended on the grounds that Plaintiff failed to explain why she needed to value her trust’s shares.  The Company argued that Woods had to point to some reason for valuing her shares, such as evidence that she has a desire to sell her shares, buy out another family member, personal estate planning, apply for credit, make an offer to purchase the Company, etc.

The Court did not find this argument persuasive.  According to Vice Chancellor Laster:

The Company’s position is contrary to Delaware law. It would require that a stockholder establish both a proper purpose (valuing shares) and an end use for the resulting valuation. Delaware law does not require that a stockholder establish both a purpose for seeking an inspection and an end to which the fruits of the inspection will be put. Cf. Lebanon Cty. Emps.’ Ret. Fund v. AmerisourceBergen Corp., 2020 WL 132752, at *11–14 (Del. Ch. Jan. 13, 2020). It is sufficient under Delaware law that a stockholder has a proper purpose reasonable related to its interests as a stockholder, such as valuing its shares. See 8 Del. C. § 220(b).

Accordingly, the Court granted Plaintiff’s books and records demand.

This decision is an important read for litigants to a Section 220 demand, in which a stated purpose of the demand is to value shares in a Delaware corporation.  A stockholder need not go one step further and actually establish why valuation is sought.

Finally, the decision sets forth a helpful list of previously approved proper purposes under Delaware law in connection with a books and records demand.  The list below is as follows:

  • to investigate allegedly improper transactions or mismanagement;
  • to clarify an unexplained discrepancy in the corporation’s financial statements regarding assets;
  • to investigate the possibility of an improper transfer of assets out of the corporation;
  • to ascertain the value of his stock;
  • to aid litigation he has instituted and to contact other stockholders regarding litigation and invite their association with him in the case;
  • “[t]o inform fellow shareholders of one’s view concerning the wisdom or fairness, from the point of view of the shareholders, of a proposed recapitalization and to encourage fellow shareholders to seek appraisal”;
  • “to discuss corporate finances and management’s inadequacies, and then, depending on the responses, determine stockholder sentiment for either a change in management or a sale pursuant to a tender offer”;
  • to inquire into the independence, good faith, and due care of a special committee formed to consider a demand to institute derivative litigation;
  • to communicate with other stockholders regarding a tender offer;
  • to communicate with other stockholders in order to effectuate changes in management policies;
  • to investigate the stockholder’s possible entitlement to oversubscription privileges in connection with a rights offering;
  • to determine an individual’s suitability to serve as a director;
  • to obtain names and addresses of stockholders for a contemplated proxy solicitation; or
  • to obtain particularized facts needed to adequately allege demand futility after the corporation has admitted engaging in backdating stock options.

Slip op. at 8-10 (citations omitted).

 

The recent decision of SolarReserve CSP Holdings, LLC v. Tonopah Solar Energy, LLC, C.A. No. 2020-0064-JRS (Del. Ch. July 24, 2020), handed down by the Delaware Court of Chancery, is an important read for any litigant involved in a books and records demand, where the party seeking information has assigned its interests in the company to a non-party.  Of significance to this action, the Court had previously denied equitable relief by the plaintiff on similar grounds, prompting Vice Chancellor Slights to note that this action, in the words of the great Yogi Berra, is “déjà vu all over again.”

Background

In this case, the plaintiff, SolarReserve CSP Holdings, LLC (“SolarReserve”) sought inspection of certain books and records of Tonopah Solar Energy, LLC (“Tonopah” or “Company”) under Tonopah’s Third Amended and Restated Limited Liability Company Agreement (“LLC Agreement”).  Tonopah defended on the grounds that SolarReserve was no longer associated with the Company, and therefore lacked rights to inspect its books and records under the LLC Agreement.

Notably, SolarReserve previously brought an action seeking the equitable dissolution of Tonopah, SolarReserve CSP Holdings LLC v. Tonopah Solar Energy LLC, C.A. No. 2019-0791-JRS (Del. Ch., Mar. 18, 2020).  That action was denied earlier this year on the grounds that it is neither a member nor manager of Tonopah, and that the complaint failed to allege facts supporting the “extreme remedy” of equitable dissolution of a Delaware LLC.  A link to the March 18, 2020 opinion can be found here.

Analysis

SolarReserve had previously assigned its claims against the Company to an unaffiliated third party, and under the agreement, any recovery would go to the assignee.  As such, the Court found that SolarReserve was not the real party in interest under Chancery Rule 17(a).  Moreover, the Court found that because the assignee has no information rights under the LLC Agreement, it likewise has no right to the information that SolarReserve seeks.

According to the March 18, 2020 opinion, Tonopah is a federally funded, nonoperational $1 billion solar energy project in Nevada.  Initially, SolarReserve was the sole owner of Tonopah, having invested $90 million into the Company.  However, after expenses mounted, SolarReserve was able to locate investors to finance the project, but in exchange gave up its direct interest in the Company.

In finding that SolarReserve lacked standing under Rule 17(a), the Court found that Plaintiff had transferred all of its claims against the Company to nonparty, CMB Infrastructure Investment Group IX, L.P. (“CMB”), a lender to SolarReserve.  CMB is not in the solar power business and is unaffiliated with SolarReserve.  Vice Chancellor Slights also struck down Plaintiff’s argument that, under the terms of the assignment, CMB may act as the “attorney-in-fact” for SolarReserve.  The Court disagreed, given that, under the assignment, the right to maintain the lawsuit belonged not to SolarReserve, but to non-party CMB.  Moreover, the Court noted that “multiple courts have recognized that ‘a grant of a mere power of attorney, short of an assignment of a claim, does not change the real party in interest.'”  Slip op. at 14. (citations omitted).

Further, Vice Chancellor Slights rejected Plaintiff’s argument that Tonopah failed to timely raise its defense that Plaintiff was not the real party in interest.  The Court noted that a Rule 17(a) defense is not an affirmative defense that must be raised in a responsive pleading, and nonetheless, Tonopah raised the defense in its Answer, in the Pretrial Order, and in its Answering Brief.  Accordingly, the Court was satisfied that a “reasonable time has been allowed” after the Company raised its objection under Rule 17, and dismissal of SolarReserve’s claim is therefore not premature.

Finally, the Court rejected SolarReserve’s argument that CMB can be joined to the proceeding as a substitute plaintiff under Chancery Rule 25(c).  Characterizing the argument as a “last-ditch effort to escape Rule 17”, the Court noted that Rule 25(c) only applies “where there has been a transfer of interest during the pendency of an action.”  Slip Op. at 16 (citations omitted).  Here, the assignment was made well before the litigation commenced.  In addition, the Court also held that the LLC Agreement only provided SolarReserve rights to inspect books and records, and the agreement was not written to include information rights to SolarReserve’s assignees.

Key Takeaway

This decision is an important read for parties to a books and records demand, where the party seeking information has assigned its rights to a non-party.  Had the LLC Agreement at issue provided for inspection rights to an assignee of a member, and the lawsuit was commenced not by SolarReserve but by the assignee (CMB), then the result could have been different.  Parties to an LLC agreement should be careful not to assume that an assignee’s right to information is preserved through an assignment, unless that right has been specifically provided for in the LLC agreement.

Time will tell if SolarReserve files an appeal, because, as Mr. Berra has also famously said: “It ain’t over ’til it’s over.”

In light of the ongoing coronavirus pandemic, the Delaware bar exam has been cancelled this year, according to an announcement by the Court issued on July 24, 2020.  The bar examination, usually scheduled in late July, had previously been rescheduled to September 9th to 11th.

Pursuant to the announcement, in lieu of the bar exam, Delaware’s Board of Bar Examiners is “working with the Supreme Court to implement a temporary limited practice rule that will allow many of this year’s bar candidates to perform legal work in Delaware, under the supervision of a Delaware lawyer, until the next administration of the Bar Exam.”  The announcement noted that nearly 60% of the candidates taking the Delaware bar exam are from out of state, many of whom are from “hot spots”, and some of whom are subject to quarantine requirements in their home state.

Delaware is traditionally considered one of the hardest bar examinations in the country, with a typical passing rate on average of approximately 50 to 60%.  The exam is offered only once per year.  Stay tuned for further updates on this front.

Earlier in June 2020, the Delaware Court of Chancery has issued its Courtroom Protocols, that are being implemented, effective June 8, 2020, in conjunction with the reopening of the courthouses.  A high-level summary of the new practices and procedures are set forth below:

  • All attorneys and members of the public will be screened upon entering a State courthouse in accordance with the protocols set forth in the Reopening Plan.
  • The Reopening Plan requires 6 feet of social distance from all other individuals (other than someone from your household) throughout the
    courthouse and in courtrooms.
  • Video streaming of hearings and trials via a YouTube channel will be available in courtrooms A and B in New Castle County and the main courtroom in Sussex County.
  • Any member of the press who wishes to attend a hearing or trial in-person is requested to file a letter so advising the court at least five business days before the proceeding.
  • All participants, including non-litigants, are required to wear a face covering or a mask while in the courtroom.
  • A staff member will monitor the hallway outside the courtroom and will direct participants to their seats to ensure proper social distancing.
  • Markings have been placed in the courtrooms identifying where participants may sit consistent with social distancing requirements.
  • Tabletop podiums and microphones will be installed at each of the two counsel tables at the front of the courtroom.
  • The ELMO projector and the center podium in the courtroom will not be available for use.
  • Counsel should make every effort to plan their presentations to avoid the need to approach the bench or the witness stand.
  • Counsel must deliver copies of demonstratives to chambers and opposing counsel at least one day before a courtroom appearance.
  • Counsel may bring their phones into the courtroom but they must be turned off (and not just silenced) during a courtroom proceeding.
  • The courtroom will be cleaned after each hearing or trial day.

Out of state attorneys should consult with their Delaware counsel to ensure proper compliance with the above protocols.

 

Section 273 of the Delaware General Corporation Law (the “DGCL”) provides a basis for the dissolution of a deadlocked “joint venture” corporation, in which two equal shareholders cannot agree on whether to discontinue the corporation.  However, the Delaware Limited Liability Act (“LLC Act”) does not have a provision similar to 8 Del. C. § 273 providing for the dissolution of a deadlocked LLC.  Nor does the Delaware Revised Uniform Limited Partnership Act.

Notably, when a 50/50 member of a Delaware limited liability company moves for dissolution, the Delaware Court of Chancery has analogized the situation to an application made under Section 273 of the DGCL for a judicial dissolution of a joint venture corporation.  See Achaian, Inc. v. Leemon Family LLC25 A.3d 800, 812 (Del. Ch. 2011).  There, the Delaware Court of Chancery denied a motion to dismiss in which petitioning member adequately alleged the elements under Section 273 of the DGCL, even though the underlying entity was a limited liability company, not a corporation.

Therefore, a petitioning member of a Delaware limited liability company must satisfy the following three prerequisites in order to adequately state a claim for dissolution of such an alternative entity with two deadlocked members of equal ownership:

  • The limited liability company only has two members, each owning 50% of the company.
  • The members cannot reach an agreement on whether to continue the limited liability company.
  • A member petitions the Court stating that it desires to discontinue the limited liability company and dispose of its assets in a plan to be agreed upon by both stockholders, or, if no plan can be agreed upon, then to dissolve the limited liability company.

Of course, dissolution is an equitable remedy that is exercised at the discretion of the court, and the petition may be subject to appropriate equitable defenses raised by the opposing party.

The Delaware Supreme Court recently issued a 50-page written opinion in Murfey, et al. v. WHC Ventures, LLC, et al., Del. Supr., No 294, 2019 (July 13, 2020), granting the limited partners’ demand for the K-1 tax returns issued to other limited partners, and overturning the Delaware Court of Chancery’s denial of such a request.  This decision is an important read for any litigant making a demand for books and records when those rights are governed by contract.

The limited partnership agreements of the Limited Partnerships provided that limited partners could inspect, upon a showing of a proper purpose, the following documents (among others):

  • the partnership tax returns, and
  • information related to the name, address, capital contributions, and partnership percentage of each limited partner.

Plaintiffs below, appellants, set forth two purposes in their demand letter: valuation of their limited partnership interests, and to investigate mismanagement and wrongdoing.  While the General Partner of the Limited Partnerships made various financials of such entities available for inspection, the General Partner would not make available K-1s issued to other limited partners to the Plaintiffs  The K-1s were the only documents that would reflect the ownership interests of other limited partners of the Limited Partnerships.  The General Partner argued, among other things, that the K-1s were not “necessary and essential” for the Plaintiffs to value their respective interests in the Limited Partnerships.

The Delaware Supreme Court rejected the General Partner’s argument that the requested documents needed to be “necessary and essential”, finding that the requested K-1s were within the scope of the limited partnership agreements.  That condition was not expressly conditioned by the partnership agreements.  Rather, such documents permitted the General Partner to argue that providing inspection of certain documents was not in the best interests of the Partnerships, but the General Partner did not make that argument.

The dissent took a different view, stating that language of the limiter partnership agreements at issue closely tracked Section 17-305 of the Delaware Revised Uniform Limited Partnership Act (“Section 17-305”), and because a “necessary and essential” standard is imposed in an analogous books and records statute, Section 220 of the Delaware General Corporation Law, a similar standard should be applied in this instance.

Interestingly, the written opinion does not address whether, under the plain terms of Section 17-305, a limited partner must demonstrate that the records specifically identified in that statute are “necessary and essential” to a stated purpose in the demand.  The High Court held that because appellants’ demand for inspection were governed by the partnership agreements at issue, it did not need to address that issue.

N.B. The author of this blog represented the Plaintiffs/Appellants in this matter.