Books and records inspection demands commonly arise in connection with a major transaction of a Delaware corporation, including a merger. The decision of Kosinski v. GGP, Inc., C.A. No. 2018-0540-KSJM (Del. Ch. Aug. 29, 2019) involved such a demand to investigate mismanagement, including whether plaintiff had established a “credible basis” to infer mismanagement.

In Kosinski, a real estate company GGP, Inc. was acquired by another real estate company already owning a percentage of GGP’s common stock.  Plaintiff brought a Section 220 demand arguing that the buyer of GGP was GGP’s de facto controlling shareholder, and that the procedural protections set forth by the Delaware Supreme Court in Kahn v. M & F Worldwide Corp., 88 A.3d 635 (Del. 2014), which required deferential review of a merger process involving a controller, had failed to be implemented.

In opposition, GGP challenged plaintiff’s stated purposes for inspection, arguing that it had formed a special committee to negotiate the merger consistent with Kahn.  However, the Court found that plaintiff pointed to facts suggesting that the special committee failed to obtain a fair price and that its members potentially were interested or lacked independence.   

Thus, plaintiff’s Section 220 demand was granted. The Court of Chancery held that because procedural protections were lacking, the transaction may not have been at arm’s length, and that plaintiff had demonstrated facts to established a “credible basis” to investigate potential breaches of fiduciary duty.

Conclusion

In connection with a merger, a corporation should ensure that all procedural protections are met under under Kahn v. M&F Worldwide Corp. Otherwise, it may be ordered to make documents available for inspection under 8 Del. C. § 220, which could lead to further litigation and potential liability.

Carl D. Neff is a partner with the law firm of FisherBroyles, LLP, and practices in Delaware.  You can reach Carl at (302) 482-4244 or at Carl.Neff@FisherBroyles.com.

A question often arises as to whether a party making a books and records demand under 8 Del. C. § 220 must enter into a confidentiality agreement in order to inspect responsive documents of the corporation.

The Delaware Supreme Court, in the decision of Tiger v. Boast Apparel, Inc., 214 A.3d 933 (Del. Aug. 7, 2019), shed light on this question. In this opinion, the High Court held that conditioning the inspection of documents demanded under Section 220 of the Delaware General Corporation Law (“DGCL”) upon entry into a confidentiality agreement should be the exception, not the rule, and justification for confidentiality must be provided by the corporation in order to be enforceable.

In the memorandum opinion, the Delaware Supreme Court wrote:

We hold that, although the Court of Chancery may—and typically does— condition Section 220 inspections on the entry of a reasonable confidentiality order, such inspections are not subject to a presumption of confidentiality. We further hold that when the court, in the exercise of its discretion, enters a confidentiality order, the order’s temporal duration is not dependent on a showing of the absence of exigent circumstances by the stockholder. Rather, the Court of Chancery should weigh the stockholder’s legitimate interests in free communication against the corporation’s legitimate interests in confidentiality.

Id. at 934.

In light of this ruling, Delaware corporations receiving a Section 220 inspection demand should be prepared to demonstrate the need for confidentiality, and stockholders making such a demand should be prepared to address the need for free and open communication in connection with the inspection materials.

Carl D. Neff is a partner with the law firm of FisherBroyles, LLP, and practices in Delaware.  You can reach Carl at (302) 482-4244 or at Carl.Neff@FisherBroyles.com.

Delaware, long viewed to be one of the most business-friendly jurisdictions in the country, has joined the ever-expanding list of jurisdictions that no longer give businesses the benefit of the doubt when it comes to restrictive covenants.

Partners Christina Bost Seaton, Amy Epstein Gluck and I explored this issue in a recent “Client Alert”, which is set forth herein.

Traditionally, the Delaware Court of Chancery has applied a “less searching” inquiry into the fairness of a restrictive covenant when that covenant was entered into in the context of a sale of a business.  In these cases, the Court of Chancery tends to enforce non-competes, because of the overall viewpoint that when an employee sells their business, they already receive significant financial compensation and actively negotiate the agreements using sophisticated counsel. Accordingly, courts do not have the same concerns about fairness as they do with a non-compete that an employee agrees to at the start of employment.

The Court of Chancery has changed its tune. In a trio of recent decisions, the Court has decried restrictive covenants that companies should have known were so overly broad so as not to protect their legitimate protective interests.

As a refresher, Delaware Courts generally enforce a restrictive covenant, such as a non-compete or non-solicitation provision, if: (1) it meets Delaware’s requirements to be an enforceable contract, which requires (a) mutual assent, (b) expressed by a valid offer and acceptance, (c) adequate consideration, and (d) capacity; (2) is reasonable in scope (i.e., the types of activities that are prohibited, and the locations in which they are prohibited) and in duration (i.e., the length of the restrictive covenant); (3) protects the employer’s “legitimate protectible interest”; and (4) is, on the balance, equitable.  As in most states, non-competes are typically subject to the highest scrutiny, non-solicitation provisions are subject to somewhat less scrutiny, and non-competes in the sale of a business are traditionally subject to the lowest scrutiny.

Of the recent trio of cases, the first to call this traditional understanding into question was Kodiak Building Partners, LLC v. Adams, C.A. No. 2022-0311-MTZ (Del. Ch. Oct. 6, 2022). There, Kodiak Building Partners (“Kodiak”) acquired Northwest Building Components, Inc. (“Northwest”), a small manufacturer.  Philip Adams (“Adams”) owned 8% of Northwest and worked as its General Manager.  As part of the deal, Adams received around $1 million.  In exchange, Adams signed a new agreement, which included both non-compete and non-solicitation provisions, and agreed not to engage in any activity that competed with the “Business,” which was defined to include services that were never offered by Northwest.  Adams also agreed not to solicit customers or clients of Northwest or of the “Company Group,” which included the buyer, its subsidiaries, and their “affiliates.”  The geographical scope was within 100 miles of any location where a “Company Group” member did business.

The Delaware Court of Chancery refused to enforce the non-compete and the non-solicitation provisions.

First, Vice Chancellor Zurn held that, while purchasers have a right to protect the goodwill of the business that they acquire, the agreement as written went far beyond that objective because it covered the business of the acquirer and other businesses in the Company Group as well: “Restrictive covenants in connection with the sale of a business legitimately protect only the purchased asset’s goodwill and competitive space that its employees developed or maintained.” Slip op. at 22. The Court further held that buyers can not “restrict[] the target’s employees from competing in other industries in which the acquirer also happened to invest.” Id. at 22-23.  The Court of Chancery also found that the geographic scope was overbroad because it went beyond the territories in which Northwest had operated.

The next case in this recent triumvirate, Ainslie v. Cantor Fitzgerald, LP, Consol. C.A. No. 9436-VCZ (Del. Ch. Jan 4, 2023), involved capital distributions to four partners over four years after they withdrew from the partnership.  If, however, the partners competed during that four-year payout period, they would forfeit their distributions. The effect of the agreement was that the restricted period was four years in length. The Court refused to enforce the agreement.

Even under the more lenient “sale of business” standard, Vice Chancellor Zurn nonetheless held that the forfeiture provision was unreasonable because of the four-year duration and the overly broad definition of “competitive activities.” That definition prohibited activities related to affiliates and not just the entity with which the former partner had been employed. The Court determined that there was no reason to believe that the former employees had any information regarding those entities, and, relying on Kodiak, the Court refused to blue-pencil the restrictions and rendered the entire agreement unenforceable.

Finally, most recently, in Intertek Testing Services NA, Inc. v. Eastman, C.A. No. 2022-0853-LWW (Del. Ch. Mar. 16, 2023), the Court of Chancery again refused to blue-pencil an overbroad agreement.  In that case, Intertek Testing Services, NA, Inc. (“Intertek”) purchased Alchemy Investment Holdings (“Alchemy”), which provided workforce training and consulting to food and cannabis companies.  Eastman, the co-founder, CEO, and a major stockholder of Alchemy, received $10 million in connection with the sale.  Eastman also agreed to a five year non-compete prohibiting him from competing with any business anywhere in the world competitive with Alchemy or its subsidiaries, as conducted by them as of the closing date.  Vice Chancellor Will determined that the global scope was overbroad, particularly because the buyer did not even allege that Alchemy engaged in a worldwide business.  The Court of Chancery refused to blue-pencil the restrictions and struck the entire agreement.

What are the takeaways?

These cases signal the end of the well-worn practice by buyers of attempting to preclude competition against the buyer’s business as well as the acquired business.  While acquirers have long gotten away with this practice due to the Court of Chancery’s willingness to blue-pencil restrictive covenants, such days are over.  Thus, when drafting new restrictive covenants as part of an acquisition, acquirers must limit the scope to the target company’s business.

Moreover, if the Court of Chancery is applying this level of scrutiny in the context of a sale of a business, it certainly will apply at least this level of scrutiny to more routine restrictive covenants in the employment context.  Thus, when an acquirer inherits employment agreements that already contain restrictive covenants, if those agreements (like the one in the Kodiak case), by their terms, prohibit the employee from competing with all present and future parents, subsidiaries, and affiliates, there is now a strong reason to believe that those agreements would not be enforceable in Delaware.

We strongly suggest that all companies relying on restrictive covenants under Delaware law review their agreements under the rubric of the three cases discussed here to determine whether new agreements are advisable.  Relying on governing law in Delaware is no longer a panacea for overly broad restrictive covenants.

In the recent decision of Schoenmann v. Irvin, et al., C.A. No. 2021-0326-SG (Del. Ch. Jun. 2, 2022), the Delaware Court of Chancery denied in part and granted in part Defendants’ motion to dismiss Plaintiff’s direct and derivative claims against Clear Align, LLC and its President, CEO and majority Board member, Angelique Irvin.  While some uncommon issues were addressed, the Court took note of the “plaintiff-friendly inferences that attend a motion to dismiss” (slip op. at 26) and found that certain claims were “reasonably conceivable” and thus survived the motion to dismiss.

First, Defendant Irvin sought dismissal of Schoenmann’s claim that Irvin had breached Clear Align’s LLC Agreement by making non-pro rata distributions to herself on the basis that the statute of limitations had run.  Schoenmann argued the statute had been tolled based on his reasonable reliance on Irvin as a fiduciary, and Irvin countered that Schoenmann had information rights as a Board member and should be held to a higher knowledge standard. The Court found that the facts pled led to a reasonable inference that Irvin had potentially kept certain Board operations from Schoenmann and, thus, the statute of limitations could be found to have tolled. For those years not barred by the statute, Vice Chancellor Glasscock found the allegations “skimpy” but sufficiently pled such that the claim was reasonably conceivable, and Irvin could defendant against it.  (Mem. Op. at 27.)

Second, the Court of Chancery found that Schoenmann failed to state a claim that Irvin breached the implied covenant of good faith and fair dealing when she removed Schoenmann from the Board for initiating an internal investigation.  The Company’s LLC Agreement expressly authorized Irvin to remove a director with or without cause and, under Delaware law, a claim for breach of the implied covenant cannot stand if the conduct is allowed by corporate agreement.

Next, Defendants asked the Court to dismiss Schoenmann’s derivative claims on the grounds that he did not adequately plead that a demand made upon the Board of Directors would have been futile.  This claim was complicated by the frequently changing composition of the Board, as well as pleadings that Irvin often disregarded corporate formalities and documentation.  Giving the Plaintiff the benefit of reasonable inferences, though, Vice Chancellor Glasscock found that Schoenmann had satisfied this standard through facts pled which suggest Irvin’s position could exert considerable influence over other Board members, such that the majority of members could not exercise disinterested judgment had a demand been issued.

Having established demand futility, Plaintiff’s derivative breach of fiduciary duty claim against Irvin was allowed to proceed.  However, Vice Chancellor found that Schoenmann had not adequately pled his derivative claim for breach of contract as there was simply no contractual basis for the claim.

Key Takeaway:  Litigants pursuing a motion to dismiss should be aware that the Court of Chancery will resolve all inferences or questions of fact in the plaintiff’s favor.  Nonetheless, a claim may be susceptible to dismissal, even under Delaware’s plaintiff-friendly pleading standard, when it is unsupported by the underlying contract at issue.

Carl D. Neff is a partner with the law firm of FisherBroyles, LLP, and practices in Delaware.  You can reach Carl at (302) 482-4244 or at Carl.Neff@FisherBroyles.com.

In the decision of Deann M. Totta, et al. v. CCSB Financial Corp., C.A. No. 2021-0173-KSJM (Del. Ch. May 31, 2022), the Court of Chancery held that the board of directors of Defendant, CCSB Financial Corp. (“CCSB”), misapplied a vote aggregation provision in the corporation’s charter that disenfranchised the shareholder Plaintiffs and, furthermore, was unenforceable under equitable principles.

CCSB’s charter includes a provision which prohibits shareholders from exercising more than 10% of the company’s voting power in an election (the “Voting Limitation”).  Facing a proxy contest from one of the named Plaintiffs, Park G.P., Inc., the directors aggregated Plaintiffs’ shares on the grounds that they were acting in concert and, pursuant to the Voting Limitation, did not count Plaintiffs’ votes above the 10% limit.  This instruction caused Plaintiffs’ nominees to lose the Board election, and Plaintiffs accordingly filed suit under 8 Del. C. § 225 to invalidate the Board’s instruction.

[For a general discussion of Section 225 of the DGCL, which permits challenges to an election of directors of a Delaware corporation, click here.]

As a threshold matter, CCSB argued that the Court should apply the highly deferential business judgment rule as its standard of review, primarily based on a provision in its charter that states any application by the board of the Voting Limitation “‘shall be conclusive and binding upon the Corporation and its stockholders.’”  (Mem. Op. at 4-5.)  Chancellor McCormick denied this reasoning on the grounds that a corporation cannot alter its directors’ fundamental fiduciary obligations unless such alteration has been authorized by statute—which it has not.  Therefore, the Court applied the well-established standard of review under Delaware corporate law that requires the Board’s actions to be tested twice—first, to determine whether the action was legally compliant and, second, to determine whether the action was equitable.

Applying this two-step analysis, the Court of Chancery found that the Voting Limitation does provide a basis for the Board to exclude stockholder votes when acting in concert, but found that the Plaintiffs had not, in fact, acted in concert.  A simple agreement that stockholders vote similarly is insufficient to prove an action in concert—there must be an agreement, arrangement or understanding of the alignment, which was not present here.

Finally, the Court of Chancery also found that the Board’s vote instruction did not satisfy the equitable test articulated under Blasius Industries, Inc. v. Atlas Corp.  According to Chancellor McCormick, Defendant’s argument that it must protect its shareholders from Plaintiffs’ alleged effort to take control of the company assumed that the directors knew better than the shareholders, which is not a legitimate reason to limit stockholder votes.  Therefore, the Court of Chancery found that the Board’s exercise of the Voting Limitation was both legally invalid and failed under Blasius’s equitable test.

Key Takeaway: An application of a voting limitation will be assessed under the “twice-tested” standard of review to assess legality and equitability.  Directors should remember that the shareholders have a fundamental right to exercise their voting power—a right that the Court of Chancery will be hesitant to curtail without a compelling, legitimate reason.

Carl D. Neff is a partner with the law firm of FisherBroyles, LLP, and practices in Delaware.  You can reach Carl at (302) 482-4244 or at Carl.Neff@FisherBroyles.com.

In the recent decision of Oklahoma Firefighters Pension and Retirement System v. Amazon.com, Inc., C.A. No. 2021-1484-LWW (Del. Ch. Jun. 1, 2022) (Mem. Op.), the Court of Chancery denied Plaintiff’s Section 220 request to demand additional inspection of Amazon’s books and records, finding that Plaintiff had not set forth a proper purpose for its investigation and that Amazon had adequately responded to Plaintiff’s demand.

Plaintiff filed its demand under 8 Del. C. § 220 to inspect Amazon’s books and records to examine potential corporate mismanagement and determine the independence and disinterestedness of Amazon’s directors.  The demand sought nineteen different categories of documents spanning eleven years.  Although Amazon questioned the legitimacy of Plaintiff’s purpose, it agreed to produce a targeted set of responsive materials, including relevant Board or committee meeting minutes and redacting any non-responsive content.  Plaintiff, in turn, filed this litigation to demand production of all documents responsive to its Section 220 demand.

The Court found that Plaintiff had not, as a threshold matter, stated a proper purpose for its investigation.  First, Plaintiff’s reference to closed or pending investigations and litigation failed to establish a credible basis for its desire to investigate possible mismanagement at Amazon.  The investigations and litigation had either closed without any adverse findings or were pending, and the only evidence of wrongdoing—a fine issued to Amazon from Italy—was irrelevant as Plaintiff only sought to investigate potential U.S. antitrust violations.  The Court found that Plaintiff had also failed to provide a credible basis for its desire to investigate the directors’ independence—stockholder curiosity is insufficient under Delaware law, and any evidence presented by Plaintiff was more speculative than reliable.

Perhaps more importantly, though, the Court of Chancery found that Plaintiff’s request for additional document production pursuant to 8 Del. C. § 220 failed because Amazon had already complied with Plaintiff’s demand.  Specifically, the Court found that Plaintiff had not shown that investigation of the additional books and records sought was essential to its investigation.  The Court also found that Amazon had produced all reasonably responsive documents, stating: “[f]ormal board-level documents are often the beginning and end of a Section 220 production where a plaintiff aims to investigate whether directors exercised proper oversight.”  (Mem. Op., at 30-31.)  In fact, the Court went so far as to commend Amazon for its effort to cooperate with Plaintiff by not outright rejecting its demand, but instead producing the core board materials that typically satisfy a Section 220 request.  Plaintiff had not justified its need for any specific documentation past what Amazon had already produced and, therefore, was overreaching.

Key Takeaway: When issuing a Section 220 demand to inspect corporate books and records, a plaintiff should first heed this Court’s decision by including a proper purpose for its investigation with a credible basis for the suspected misconduct.  Additionally, the responding company may be able to restrict its production to only those board and committee minutes that are relevant to the plaintiff’s stated purpose for inspection.

Carl D. Neff is a partner with the law firm of FisherBroyles, LLP, and practices in Delaware.  You can reach Carl at (302) 482-4244 or at Carl.Neff@FisherBroyles.com.

In a recent action brought under Section 225 of the DGCL, the Delaware Court of Chancery validated a written consent removing Defendants Long Deng and Mark Fang from iFresh, Inc.’s (“iFresh”) Board of Directors and appointing new directors in their stead. A summary of the decision can be found here. Defendants filed an appeal with the Delaware Supreme Court and then sought a stay pending that appeal, which the Court of Chancery has now denied in Dengrong Zhou v. Long Deng and Mark Fang, C.A. No. 2021-0026-JRS (Del. Ch. May 23, 2022).

The Court’s analysis followed the factors laid out in Kirpat, Inc. v. Del. Alcoholic Beverage Control Comm’n, 741 A.2d 356 (Del. 1998): (i) preliminary assessment on the movant’s likelihood of appellate success; (ii) whether the movant will suffer irreparable harm without a stay; (iii) whether another interested party would suffer substantial harm with a stay; and (iv) whether a stay serves the public interest.  Because Delaware law supports granting a stay if factors (ii) through (iv) weigh in favor of one, Vice Chancellor Slights began his analysis there.

Under Kirpat factor (ii), Defendants argued that a change in iFresh’s Board of Directors would risk unauthorized Board action and, thus, irreparable harm.  Yet the Court of Chancery found that loss of board control alone does not constitute irreparable harm—a party must identify injury other than strict compliance with the Court’s Order, and Defendants had not done so here.  Under Kirpat factor (iii), Defendants argued the stay would be brief and unharmful to other parties, but could negatively affect iFresh’s relationship with its commercial lender.  Vice Chancellor Slights found this argument equally unpersuasive—Defendants had not surrendered their Board positions for over a year following the written consent, and further delay was unnecessary.  The Court also noted that the lender was perfectly capable of protecting itself from a change in Board control through negotiation of favorable forbearance terms.  Lastly, in consideration of Kirpat factor (iv), the Court decidedly found that control of a company’s Board of Directors is a predominantly private interest, not public, and any public interest would nonetheless be countered by Delaware’s interest in quickly executing on actions brought under Section 225.

Only after finding that Kirpat factors (ii) through (iv) weigh in favor of a stay must a court analyze the likelihood of the movant’s success on appeal.  While that was not the case here, the Court of Chancery still found that the Defendants had not offered serious legal questions for review by the Delaware Supreme Court.  Specifically, the Court noted that its Section 225 Opinion “did not break new legal ground or extend settled law.”  Id. at par. 9.  In light of each Kirpat factor, Vice Chancellor Slights denied Defendants’ motion for a stay.

Key Takeaway:  This opinion holds that loss of board control alone does not constitute irreparable harm and likewise does not support a stay of a Section 225 order pending appeal.  Similarly, the constitution of a company’s Board of Directors is a predominantly private issue and likely does not affect public interest such that a stay would be granted. Therefore, if a party seeks a stay pending a Section 225 appeal, it will need to articulate an injury outside of strict compliance with the Order it wants stayed.

Carl D. Neff is a partner with the law firm of FisherBroyles, LLP, and practices in Delaware.  You can reach Carl at (302) 482-4244 or at Carl.Neff@FisherBroyles.com.

In the decision of Dengrong Zhou v. Long Deng and Mark Fang, C.A. No. 2021-0026-JRS (Del. Ch. Apr. 6, 2022) (Mem. Op.), the Delaware Court of Chancery found that a majority of stakeholders from iFresh, Inc. (the “Control Group”) had validly executed a written consent (the “Consent”) removing Defendants Deng and Fang from the iFresh Board of Directors and replacing them with two new members.

Plaintiff Dengrong Zhou sought a judicial declaration affirming the Consent’s validity pursuant to 8 Del. C. § 225, and Defendants filed counterclaims alleging the Control Group had fraudulently purchased their stock in iFresh, thus rendering the Consent invalid.  As a preliminary matter, Vice Chancellor Slights made clear that a Section 225 action “is summary in nature, and narrow in purpose,” and his ruling would only determine the validity of the Consent.  Mem. Op., at 8.  The Court then addressed Defendants’ three allegations of fraud as follows.

First, Defendants claimed that iFresh’s CFO had breached her fiduciary duty by supporting Plaintiff’s purported scheme to acquire control of iFresh, and this breach had wrongfully enabled the Control Group to acquire the shares used to supplant Defendants.  Vice Chancellor Slights denied this allegation on procedural grounds—Defendants did not raise this alleged breach of fiduciary duty until their post-trial brief and, therefore, had waived the argument.

Second, Defendants sought to invalidate votes cast by one of the Control Group stockholders, HK Xu Ding Co. Ltd. (“HK XD”), for breach of contract because it initially only paid $5 million of a $7 million stock purchase in iFresh (of note, HK XD paid the additional $2 million to Deng after he prevailed on a breach of contract claim in New York).  While the Court acknowledged that a breach of contract could invalidate a corporate election, that breach of contract must relate to the election for it to also affect its validity.  The Court specifically stated that its previous decision in Zohar II 2005-1, Ltd. V. FSAR Hldgs., Inc., 2017 WL 5956877 (Del. Ch. Nov. 30, 2017) “does not stand for the proposition that any showing of a breach of contract provides a basis to set aside a stockholder vote in a Section 225 action.”  Mem. Op. at 19 (emphasis in original).  Accordingly, the Court ruled that the breach of contract by HD XD had already been resolved and did not affect the validity of the Consent.

Third, Defendants alleged that the Control Group members had fraudulently obtained their shares in iFresh, and the Court separately analyzed each of the three stock purchase agreements at issue.  In general, though, the Court noted that each allegation relied on a common law duty for a shareholder to disclose intent to take control of a company when purchasing stock in that company.  Vice Chancellor Slights found that no such common law duty existed and for this reason, among others, Defendants’ allegations of fraud failed.  Having denied each of Defendants’ claims of breach of fiduciary duty, breach of contract, and fraud, the Court of Chancery found the Consent was valid in removing Defendants from iFresh’s Board of Directors and replacing them with alternative members.

Key Takeaway: Any general allegation of fraud will not invalidate a corporate election under Section 225.  Instead, a party seeking such invalidation will need to show how a breach of duty relates to the corporate election at issue.  And, specifically, Delaware does not enforce a common law duty for a stockholder to disclose an intent to take control of a company when purchasing that company’s stock.

Carl D. Neff is a partner with the law firm of FisherBroyles, LLP, and practices in Delaware.  You can reach Carl at (302) 482-4244 or at Carl.Neff@FisherBroyles.com.

In the decision of Badr Abdelhameed Dhia Jafar v. Vatican Challenge 2017 LLC, C.A. No. 2020-0151-SG, 2022 WL 365142 (Del. Ch. Feb. 8, 2022) (Letter Op.), the Delaware Court of Chancery held the Plaintiff, a member of the Defendant LLC, responsible for the fees accrued by an appointed Receiver during her oversight of records production in the Section 220 action.

Vice Chancellor Glasscock had entered a default judgment in favor of the Plaintiff in the underlying action and, accordingly, placed the first responsibility of the Receiver’s compensation on the defaulting Defendant.  However, after holding the Defendant in contempt for its failure to compensate the Receiver, the Vice Chancellor placed the secondary responsibility for compensation on the “benefiting party”—here, the Plaintiff.  Letter Op., at 6.

The Court reasoned that the Receiver had been appointed “at the request of and for the benefit of the [Plaintiff],” id., and noted that due to the Defendant’s insolvency, no funds existed from which the Defendant could pay the Receiver.  While the Plaintiff can choose to seek recoupment from the Defendant, the Court held that equity required the Plaintiff be held responsible for the fees owed under the agreed-upon Receivership Order.

The Court then analyzed the reasonableness of the Receiver’s fees.  It held that fees incurred during the performance of duties pursuant to the Receivership Order were reasonable and payable by the Plaintiff.  The fees incurred in the Receiver’s efforts to secure payment did not need to be paid by the Plaintiff, though, consistent with the general principle that a party is responsible for its own litigation costs, absent special circumstances.

Key Takeaway: Litigants seeking the appointment of a receiver to assist in a Section 220 books and records demand could ultimately be held responsible for the compensation of that receiver if the opposing party is unable to pay the receiver’s fees.

In the recent decision of In re Forum Mobile, Inc., C.A. No. 2020-0346-JTL (Del. Ch. Feb. 3, 2022), the Delaware Court of Chancery denied a petition to appoint a custodian under 8 Del. C. § 226(a)(3) where petitioner sought to take a defunct corporation whose shares are traded over the counter to use as a blank check company through a reverse merger.

We previously discussed here on this blog custodianship proceedings under Section 226 of the Delaware General Corporation Law (“DGCL”).

Vice Chancellor Laster preliminarily noted that “Delaware decisions have enforced a public policy against permitting capital markets entrepreneurs to use sections of the DGCL to revive defunct Delaware entities with still extant listings and use them as vehicles to access the public markets.” Slip op. at 1.

The Court then analyzed the text of Section 226 itself. Petitioner sought appointment of a custodian over Forum under 8 Del. C. § 226(a)(3), which allows the Court of Chancery to appoint a custodian when “[t]he corporation has abandoned its business and has failed within a reasonable time to take steps to dissolve, liquidate, or distribute its assets.”

Section 226(b) provides that “the authority of the custodian is to continue the business of the corporation and not to liquidate its affairs and distribute its assets, except when the court shall otherwise order and except in cases arising under paragraph (a)(3) of this section or § 352(a)(2) of this title.”

The Court held that a custodian appointed under Section 226(a)(3) does not have authority to continue the business of the corporation, under the express terms of Section 226(b). That is what the petitioner sought to do so in this action. Rather, a custodian appointed under Section 226(a)(3) may only liquidate the affairs of the abandoned corporation and distribute its assets.

Key Takeaway: The Forum Mobile decision makes clear that a petitioner may not rely upon Section 226(a)(3) of the DGCL to revive a defunct, publicly registered shell company as a blank check company.

Carl D. Neff is a partner with the law firm of FisherBroyles, LLP, and practices in Delaware.  You can reach Carl at (302) 482-4244 or at Carl.Neff@FisherBroyles.com.