Corporate Law Archives - That's Not Market

Interesting (believe it or not) Developments in Delaware Bylaw Law

Case tests company attempt to shift expenses related to stockholder violations of exclusive forum clause in corporate bylaws.

I’ve been out of the blog game for a while, so I am now catching up on older stuff that I find interesting. Hopefully, it is not completely out of date. But what could be more interesting than laws about corporate bylaws?

This post involves some recent developments in Delaware bylaws. The short answer:

Exclusive forum clauses are okay
Fee shifting provisions, even for stockholder action violating the exclusive forum clauses are not okay.

So far, so good.

Case: Solak v. Paylocity Holding Corporation, et al.

Brief Background

In response to another case, Delaware made a couple of changes to its corporations statute:

Section 115 was added to permit corporations to adopt bylaws requiring claims to be brought solely in Delaware if they are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or under the jurisdiction of the Court of Chancery; and
Section 109(b) was amended to provide that bylaws may not impose liability on a stockholder for attorneys’ fees or expenses of the corporation or any other party in connection with Section 115 claims.

Paylocity amended its bylaws to adopt exclusive forum bylaws and to impose liability on a stockholder who brings a Section 115 claim outside of Delaware. Stockholders were not amused by the fee-shifting provision.

The court said that the plain text of the fee-shifting bylaw violates Section 109(b) despite Paylocity’s arguments that:

Section 109(b) must be read with Section 115, thus permitting fee shifting for violations of an exclusive forum bylaw (Court: No exception in either provision to permit this exception to fee-shifting prohibition);
common law permits fee-shifting (Court: Fee-shifting is allowed in private contracts, which are not subject to the prohibition of Section 109(b)); and
the bylaw says “to the fullest extent permitted by law,” so it is limited (Court: There is no extent to which it is permitted, so it is invalid.)

Online Contracts – How Deceptive Is Too Deceptive To Form A Valid Contract?

Online contracts obtained through deception may be easier than you’d think, despite a 9th circuit opinion knocking one down.

Link: Lee v. Intelius Inc.

Have you ever purchased something online only to find recurring credit card charges for something you don’t want, didn’t ask for and never heard of? A recent 9th circuit decision shows the limits of clickthroughs to create binding contracts and the risks for consumers who click without looking.

Background

A plaintiff purchased an online background check from Intelius. After the purchase, the website offered $10.00 cash back for a survey, which also asked for an email address with a statement that entering the email constitutes an electronic signature and authorization to charge/debit their account. The plaintiff was not asked to reenter his credit card information. Following an additional click, which included a statement on the website for the background check, the website said that the click constitutes an agreement to “Offer Details” and authorized Intelius to pass the plaintiff’s information to “a service provider of Intelius.”

It turns out that the service provide was Adaptive Marketing, a third party, not part of Intelius and not mentioned by name on the website. The additional efforts were actually to purchase a monthly service from Adaptive.

The Court’s Reasoning

The arbitrator clearly saw the process to be a misleading set up to get purchasers of Intelius’ background checks to subscribe for Adaptive’s services. The description of the process was “designed to deceive.” However, this did not settle the matter.

It is clear that an electronic “signature” can be legally sufficient under Washington law even if it is not clear under what circumstances a “click” constitutes a signature.

However, the law reuires that the “essential elements” of a contract be set forth in writing, including the identification of the parties to the contract. Adaptive claimed that the parties need not be named and cited cases regarding companies doing business under assumed names. However, nothing on the website identified Adaptive as the party with whom the plaintiff was contracting. In addition, it was ambiguous at best that anyone other than Intelius was involved.

The Result

The arbitrator ruled that a contract had not been formed.

Lessons

This case was not as consumer friendly as the holding suggests. Just adding “Adaptive Marketing” in some manner on the website may have been enough to justify enforcing the contract. If the court was looking to say “We will look closely at circumstances where there is simply no way the user is purchasing some bogus subscription,” it did not exactly make a strong statement.

Even confusing and deceptive language and formatting on a website can induce the formation of an enforceable contract. However, all of the elements of a contract must be present, not just “as suggested by.”

Insider Trading – A Contrarian Take From CNBC

Should insider trading be illegal?

John Carney at CNBC posted an interesting article posing the question about whether insider trading should be a crime. In light of Michael Steinberg’s conviction for securities fraud due to his activities at SAC Capital, Carney asks who were the victims and what was the harm?

SAC Capital has been under fire for alleged insider trading. One trader was recently convicted.

In Steinberg’s case, part of the facts involved trading on early access to Dell’s earnings. Why is this a big deal?

But it’s hard to see how Steinberg’s acquisition of Dell’s earnings a day early hurt the company in any way. His trading may or may not have moved the stock price a bit but the actual release of the earnings moved it more.

Does Dell have an intellectual property right in its earnings? We don’t really recognize all corporate secrets or corporate information as protected intellectual property, much less property whose unauthorized use gives rise to criminal sanctions. There are certain categories—trade secrets, trademarks, copyrights—that are protected. But earnings aren’t trade secrets. Dell released them the very next day.

It is important to remember that Steinberg’s trading did not involve face-to-face arm’s length transactions with the counterparties. They were nameless and faceless people who never met Steinberg, knew Steinberg was in the market to buy or sell Dell shares or placed their orders with any knowledge of Steinberg and what he may have known or not known, disclosed or not disclosed. As Carney points out, regardless of what Steinberg did, each one of them would have acted in the exact same way.

What about the people who bought the shares of Dell on the day Steinberg was selling? Again, they would have been in exactly the same position regardless of whether Steinberg traded or not. Arguably, they were able to buy at a slightly better price because Steinberg’s trades would have pushed the stock slightly in the direction the stock actually moved when the earnings became public.

You’ll sometimes hear it said that the people on the other side of Steinberg’s trades were harmed because they wouldn’t have bought the shares if they had the same information he had. But that’s precisely the wrong test. The question isn’t what would they have done if they also had inside information. It’s what would they have done if Steinberg hadn’t had his information? The answer is: exactly what they did anyway. Steinberg’s possession of inside information didn’t affect them one bit.

Carney comes to a similar conclusion that I have always believed. This type of insider trading is not about protecting people. It is about (1) punishing success and profit [Ed. This is more me than Carney], and (2) a gut reaction that this behavior is wrong and should be punished. It is about addressing moral qualms, not about stopping harm.

In this respect, Carney compares this type of insider trading to blue laws.

In other words, our ban on insider trading isn’t really about protecting investors or making markets function better. It’s about expressing a moral view, much like we do with Blue Laws that ban the sale of alcohol on Sundays.

Here it is important to note that there is a school of thought that suggests insider trading should be encouraged since it makes the market more efficient by sending information about the insiders’ views of the company into the market. There are entire schools of trading based on insider transactions and Section 16 filings.

And here is where he loses me:

There’s nothing necessarily wrong with encoding morality into securities laws.

Yes, there is. We see it everyday in garbage like the ridiculous executive compensation disclosure now imposed on companies. We see it in required environmental disclosure, cybersecurity disclosure and blood minerals disclosure that probably don’t apply to most companies.

We see it every time some activist jumps up to demand that the SEC impose disclosure requirements on all companies that comport with the activists’ agenda, regardless of whether it furthers the mission of the disclosure regime for SEC reporting companies: Do investors have the information they need to make an informed investment decision? End of story.

If those issues are material to the disclosing company, they will have to be discussed. If not, this is nothing more than an extra tax (by way of time and money spent to assess and produce this nonsense) on reporting companies to pay for the whims of some vocal activists, be they outside agitators or Congressmen (who were (and probably still are) able to trade on inside information illegally in a way that would send you or I to prison).

A Brief Reaction to a Small Part of “Assessing Silicon Valley Corporate Governance Measures” Article

The Recorder recently ran an article discussing Fenwick & West’s corporate governance study. I believe F&W produces these annually, and they are excellent resources for anyone interested in the up-to-date information about corporate governance practices, particularly for Silicon Valley companies.

However, there was an interesting statement at the beginning of the article:

“When companies are seeking to establish appropriate corporate governance policies, they often look to model themselves after those titans of industry in the Standard & Poor’s 100.”

Well . . . sometimes.

More often, companies will look to the companies that:

they deem somewhat comparable to the themselves; and
they aspire to be.

Typically, that will include prominent companies in their industry, which may or may not include companies in the S&P 100, 500, Pick-A-Number. They also account for size and complexity and other factors.

For many companies, the governance practices of the S&P 100 will be far too complex and have far too many processes and procedures to have any value. There will often be fewer people in the decision-making process, fewer layers of bureaucracy and the fewer issue-specific policies for smaller companies.

That said, the F&W studies tend to be extremely valuable, and I plan to spend a good part of the weekend reading the new one. I hope your weekend is better than that.

Delaware Supreme Court Discusses Meaning of “Business Combination” In Activision Vivendi Case

As it turns out, it isn’t ambiguous.

Link: Activision Blizzard Inc. v Hayes

In an appeal of an injunction, the Delaware Supreme Court took a look at whether a stock buyback would be a “business combination” requiring stockholder approval under Activision’s bylaws.

Background

Activision Blizzard fights for its rights to buyback its shares.

In 2008 Activision bought Vivendi’s video game subsidiary for Activision shares. Vivendi also made a separate cash investment in Activision. Activision’s bylaws were amended to require approval of unaffiliated stockholders with respect to any merger, business combination or similar transaction between Activision and Vivendi. In 2012, Vivendi wanted to sell its Activision stake but found no takers. Activision agreed to a buyback, under which Vivendi would create a non-operating sub, “Amber,” to hold the assets for sale and Activision would purchase Amber. Activision did not seek stockholder approval, which was the part of the reason for the litigation, which resulted in a preliminary injunction.

Court’s Analysis

The court first looked to see if “business combination” was ambiguous. Nope.

“A provision is ambiguous only if it is “reasonably susceptible to more than one meaning,” and the fact that the parties offer two different interpretations does not create an ambiguity. Moreover, a provision “may be ambiguous when applied to one set of facts but not another. Finally, the provision must be read in context.”

The court decided that while the meaning could be ambiguous in some contexts, it was not ambiguous here because under their agreement, Vivendi will sell 429 million shares of Activision stock back to Activision. Because those shares will become treasury stock, control of Activision will shift from Vivendi to Activision’s public stockholders. Vivendi’s holdings will decrease from 61% to 12%, and Vivendi’s representation on Activision’s board will decrease from six appointees to none.

Since there was no “combination or intermingling of Vivendi’s and Activision’s businesses,” it is not a business combination. In fact it is the opposite of a business combination. These companies will be separating themselves. As a result, the stockholder approval requirement does not apply.

In addition, structuring the sale through Amber does not change the analysis. Neither the form of the transaction nor its size changes its fundamental nature. Amber is a shell created to serve as the transaction vehicle. The court stated that calling Amber a business “disregards its inert status” and “glorifies form over substance.”

The size of the deal does not change the analysis. The plaintiffs argued that it was a “value-moving” transaction. However, the bylaws do not require stockholder approval based on size of the deal.

In addition, the bylaws do not require stockholder approval for any deal between Activision and Vivendi, only specified transactions. While the Chancery Court may have been looking out for the non-interested shareholders’ interests, other provisions of the bylaws already provided for independent director approval for related party transactions.

Contracts and the Law – Beer Contracts in Mergers & Acquisitions

Labatt distributor shows why contracts must work with the law and can’t just change it.

Link: Esber Beverage Company v. Labatt USA Operating Company (Ohio Supreme Court)

Every now and then I get a request to draw up an agreement that does not jive with the law. I’ll get suggestions such as, “Just call it something else, like “Consulting Agreement.’” I have to say, “It doesn’t work that way. The contract has to work within the framework of the law. Sorry.”

How is this relevant to anything? Well, because when a manufacturer sell its rights relating to a particular brand of alcohol to a successor, the new owner can terminate any distributor’s franchise without cause. At that point, the new owner’s obligations are notice and compensation.

We learn this because Esber Beverage Company was a long-time distributor of Labatt for InBev. InBev went on to merge with Anheuser-Busch. Because easy is cheap, the U.S. Department of Justice would not allow this merger to proceed without some sort of obstacle. With no consideration at all of the good folks who distribute Labatt, the Justice Department forced the merged company to divest itself of all assets relating to Labatt. A new company backed by private equity firm KPS Capital Partners, L.P. purchased the rights to Labatt and terminated Esber.

Esber sued claiming that the statute only applied when there was no written agreement.

The court didn’t buy it.

Pursuant to the statute, every manufacturer of alcoholic beverages must offer its distributors a written franchise agreement specifying the rights and duties of each party. If the parties do not enter a written franchise agreement, a franchise relationship will arise as a matter of law when a distributor distributes products for 90 days or more. So far so good.

The statute also sets forth how to cancel or terminate a franchise. There are three situations:

With prior consent and 60 days’ notice
With “just cause,” and the statutes explains what this means.

In addition, in either case, the manufacturer must repurchase all of the terminated distributor’s unsold inventory and sales aids.

However, the statute also provides for terminating a franchise when the manufacturer sells a particular brand or product of alcoholic beverage to a successor manufacturer. If a successor manufacturer acquires all or substantially all of the stock or assets of another manufacturer, the successor manufacturer may give written notice of termination, nonrenewal, or renewal of the franchise to a distributor of the acquired product or brand. On termination of the franchise, the successor manufacturer must repurchase the distributor’s inventory and must compensate the distributor for the diminished value of the distributor’s business that is directly related to the sale of the terminated product, including the appraised market value of the distributor’s assets devoted to the sale of the terminated product and the goodwill associated with that product.

This was not enough for Esber, which asserts that the statute does not permit a successor manufacturer to terminate when the successor manufacturer has itself entered into or assumed a written contract with the distributor. The court disagreed and quoted another case for the proposition:

“When a statute’s language is clear and unambiguous, a court must apply it as written.”

It continued:

“The plain language of the statute allows the successor manufacturer to terminate a franchise. The definition of “franchise” includes both written franchise agreements and franchise agreements that have arisen by operation of law.”

As a result, the new owner can terminate Esber and Esber is entitled to compensation. However, the contract does not trump the statute.

Can Open Market Stock Purchases Resulting In Majority Control Constitute A Breach Of Fiduciary Duty?

How about the board’s granting of the right to engage in those purchases?

Answer: No.

Link: In re Sirius XM Shareholder Litigation

Background

In 2009, Sirius was hurting. Liberty Media was nice enough to provide $530 million for a 40% interest, some board seats and some consent rights. The agreement included a standstill provision preventing Liberty from gaining majority control for three years. Following the standstill period, the agreement prevented Sirius from using a poison pill or charter or bylaw amendment to interfere with additional purchases of Sirius stock by Liberty. The investment and agreement were disclosed publicly.

At the end of the standstill period, Liberty announced it would obtain a controlling position through open market purchases. Sirius opposed it, and even opposed the FCC approval that Liberty would need in order to obtain majority control. However, Liberty was able to get its majority stake.

Plaintiffs sued claiming breach of fiduciary duty on the part of Liberty and the Sirius board of directors.

Fiduciary Duty Claims Against Sirius Board

The court initially noted that the time period for fiduciary duty claims ran from the time of the agreement in 2009, and thus their claims were time barred. The plaintiffs also argued that the board should have instituted a poison pill to prevent Liberty’s additional purchases, the court said this was not the wrongful act. The plaintiff’s complaints arise out of the initial agreement in 2009, and the plaintiffs did not have a good reason for waiting to file a lawsuit. The terms of the deal were fully disclosed in 2009, and the board’s inability to stop Liberty’s purchases were based on the 2009 deal.

Anything the board did that is subject of the plaintiffs’ complaint was based upon 2009 activity and, therefore, the statute of limitations ran from 2009. As the court said, “[u]nder Delaware law, a plaintiff’s cause of action accrues at the moment of the wrongful act – not when the harmful effects of the act are felt – even if the plaintiff is unaware of the wrong.”

Fiduciary Duty Claims Against Liberty

The Plaintiffs also argued that Liberty had a fiduciary duty even if it was a non-controlling shareholder when it initially invested in 2009. This duty of fairness would preclude Liberty from buying additional shares in the open market unless the Sirius board approved the terms.

The court disposed of this claim as well. First, they are time-barred because they were still the product of the arms-length negotiations and deal in 2009 when Liberty was not even a stockholder, much less a controlling stockholder. Second, open market purchases after disclosing the intent to make such purchases do not involve any control over Sirius’ board or misuse of Sirius’ resources by Liberty. There was no allegation of insider trading or an attempt to effect a going private transaction. To the contrary, even the plaintiffs conceded that Liberty’s purchase announcement would result in the market price for the Sirius shares to increase prior to purchase. As a result, what the plaintiffs are really claiming is a repackaging of their opposition to the 2009 deal.

The only real complaint of the plaintiffs is that the board did not institute a poison pill, which was not only prohibited by contract but is not actionable under Delaware law without additional bad acts (recall the Landry’s case, Louisiana Municipal Police Employees’ Retirement System v. Fertitta, 2009 WL 2263406 (Del Ch. July 28, 2009)).

The court finished with its adherence to basic corporation law and contracts:

“There are many situations when corporations enter into contractual arrangements that have important implications for corporate control in conceivable future situations; for example, debt instruments commonly give creditors rights that, if used, may result in their assuming control. The use of such rights to obtain control in the situations specifically contemplated by those contracts does not constitute a fiduciary breach. As this court has explained, even “[a] controlling shareholder is not required to give up legal rights that it clearly possesses; this is certainly so when those legal rights arise in a non-stockholder capacity.””

I Was Quoted In An Article

. . . on the MyCorporation blog regarding LLCs vs. Corporations. I was one of the experts weighing in on this issue.

While it may seem pedestrian to practitioners, considering the amount of ink spilled over this issue, it is an ongoing item of concern for entrepreneurs.

Here is my excellent contribution:

“7. “The short answer is “it depends.” However, I have found that an LLC will often provide more flexibility in terms of division of rights and responsibilities from the default rules in many business entity statutes. There is more flexibility in terms of pass-through tax treatment with LLCs vs. corporations, even with a Subchapter S election.”

– Doug Berman, Corporate Attorney, Law Office of Douglas M. Berman“

Sage advice, indeed.

A Simple Question: What Does “Annual” in “Annual Meeting” Mean?

According to the Massachusetts Supreme Court, the answer isn’t quite so simple.

Link: Brigade Leveraged Capital Stuctures Fund, Ltd. v. PIMCO Income Strategy Fund

“Annual” means “annual,” right? How hard could it be. Let’s allow some ambiguous drafting, course of dealing and New York Stock Exchange regulations make it complicated.

Background

PIMCO is a big fund company and Brigade is an investor in two of its funds, each of which is a Massachusetts business trust.

The funds sent notices to investors of their intent to hold annual meetings as usual. Brigade sent notice that it was going to nominate a trustee for election at the annual meetings. PIMCO rescheduled the meetings to the last day of its fiscal year.

The funds’ declarations of trust require annual meetings at least 15 months after the first sale of shares and thereafter as specified in the bylaws.

The funds’ bylaws provide that annual meetings shall be held, so long as common shares are listed for trading on the NYSE, on at least an annual basis.

The NYSE requires listed companies to hold an annual shareholders’ meeting during the fiscal year.

Brigade filed suit seeking an injunction requiring PIMCO to hold the annual meeting as soon as practical and a declaration that the bylaws require an annual meeting at least once within any twelve month period.

Brigade contends that the rescheduling to nineteen months after the last annual meeting does not count as “annual,” which means within twelve months of the last annual meeting. PIMCO says “annual” means “during the fiscal year.”

What the Court Says “Annual” Means

Interpretation of Governing Documents

The court noted that the reference to the NYSE clearly means that an annual meeting must be held, at the very least, once every fiscal year, even though the bylaws do not explicitly say that.

However, the court reviewed the bylaw provision for shareholder notices together with the annual meeting requirement.¹ It also noted that the bylaws provided for a special meeting in lieu of annual meeting, which may take place outside of the “annual period,” a thirty day window following the anniversary of the previous year’s annual meeting, which is not an “annual meeting,” but a “special meeting.”

The court also noted that this interpretation is consistent with how PIMCO historically scheduled its meetings and the usual meaning of “on an annual basis.”

There is more going on here than contract interpretation, and you may already know this if you have ever dealt with this issue before a court.

The Real Issue

Many courts don’t come out and say it, but the Brigade court did. Where the bylaws are ambiguous, it will construe them against the drafters, in other words, the company.

The upshot is that courts do not like it when companies try to escape the wrath of a shareholder vote. As the court said,

“Moreover, where “bylaw provision are unclear, we resolve any doubt in favor of stockholders’ electoral rights.””

The court went on to quote a variety of shareholder friendly cases for the proposition that voting in corporate elections is a fundamental right of shareholders, and the court will not interpret ambiguous governing documents to allow the company to postpone an election.

________
¹Bylaws Section 10(c):

“To be timely, the Shareholder Notice must be delivered to or mailed and received at the principal executive offices of the Trust not less than forty- five (45) nor more than sixty (60) days prior to the first anniversary date of the date on which the Trust first mailed its proxy materials for the prior year’s annual meeting; … provided, … however, if and only if the annual meeting is not scheduled to be held within a period that commences thirty (30) days before the first anniversary date of the annual meeting for the preceding year and ends thirty (30) days after such anniversary date (an annual meeting date outside such period being referred to herein as an “Other Annual Meeting Date”), such Shareholder Notice must be given in the manner provided herein by the later of the close of business on (i) the date forty-five (45) days prior to such Other Annual Meeting Date or (ii) the tenth (10th) business day following the date such Other Annual Meeting Date is first publicly announced or disclosed” (emphasis added).