Widener Law Student’s Winning Article Critiques Courts’ Treatment of Intellectual Property Rights in Bankruptcy

Daniel J. Ritterbeck, Widener University School of Law Class of 2013, and Senior Staff Member of the Delaware Journal of Corporate Law, was recently awarded first prize in the 2012 Pennsylvania Bar Association’s Intellectual Property Writing Competition for his paper titled The Assignability of an Exclusive Copyright License in a Bankruptcy Context: The Correct Application of ‘Applicable Law.’

In 2004, the Pennsylvania Bar Association’s Intellectual Property Law Section established the writing competition to create an opportunity for second and third-year law students to express, in writing, their knowledge and interest in the areas of patents, copyrights, trademarks, trade secrets or trade dress. In his paper, Ritterbeck analyzes the effects that sections of the Bankruptcy and Copyright statutes have on the transfer of exclusive copyright licenses, and suggests how courts should approach analyzing the issue in the future.

“I’m honored to be recognized by the Pennsylvania Bar Association,” says Ritterbeck. “I’m passionate about intellectual property rights and how they relate to other complex civil issues. Consistent treatment by the courts is crucial considering the importance of intellectual property in today’s business and legal landscapes.”

As the first place winner, Ritterbeck was awarded a $2,500 cash prize, and his paper will be published in the Intellectual Property section of a forthcoming issue of the Pennsylvania Bar Association’s newsletter, and will also be available on the bar association’s website.


Various forms of intellectual property, including copyrights, continue to serve as the most valuable assets found in the portfolios of many corporations in the United States.  As the U.S. economy struggles to recover from its recent years spent in recession, many corporations are being forced to file for bankruptcy. It follows that the role intellectual property assets play in bankruptcy proceedings, especially in Chapter 11 reorganizations, is of utmost importance and the treatment they receive by the courts will have sweeping implications on debtor licensees, non-debtor licensors, and creditors alike. This is especially true in the bankruptcy context of whether a debtor licensee has the right to freely assign an exclusive copyright license without the consent of the licensor. However, no steadfast rule has been developed by and between non-bankruptcy and bankruptcy courts, despite Congressional guidance on the matter in Titles 11 and 17 of the U.S. Code.

The problem exists because the assignment of exclusive copyright licenses in a bankruptcy context is governed by applicable non-bankruptcy laws (i.e. federal copyright laws), and bankruptcy and non-bankruptcy courts are in disagreement concerning the correct application of those laws.   The problem is exacerbated by the fact that the policies underlying the two areas of law are antagonistic to say the least. This Note will argue that the Ninth Circuit’s holding in Gardner v. Nike illustrates the correct application of copyright law as it pertains to the assignability of an exclusive copyright license because the court’s holding was based on an accurate reading of 17 U.S.C. § 201(d)(2); the protections and remedies afforded to a licensee of an exclusive copyright license do not include the right to transfer a copyright absent consent from the owner of the copyright. Such an interpretation better reflects the policies underlying copyright law, and the results that follow its application are equitable to all parties involved. Therefore, the United States Bankruptcy Court for the District of Delaware should adopt the well-reasoned approach articulated in Gardner and accordingly reconsider its holding in In re Golden Books.

New Light on Conspiracy-Based Jurisdiction

 This post is authored by Benjamin Chapple (Widener Law ’13)

In Hospitalists of Delaware, LLC v. Lutz, C.A. 622-1 VCP (August 28, 2012), Vice Chancellor Parsons extensively reviews the basis for exercising personal jurisdiction over alleged co-conspirators. Here’s a brief review of the opinion:

When sued by two judgment creditors, the managers and controlling stockholder of Cubit Medical Practice Solutions, Inc. (“the Company”) consented to personal jurisdiction; however, three other defendants, all of whom are non-Delaware business entities, did not. These non-consenting defendants (BCV, BC2, and Integra) all moved to dismiss for lack of personal jurisdiction.

Hospitalist (one of the two plaintiffs) sent the Company a claims letter because the Company was failing to process and collect medical bills. This claims letter threatened suit. Plaintiffs alleged that upon receipt of this letter the defendants immediately began to hatch a plan in which they would sell or dissolve the Company and, at the same time, extract their investment from Integra (a separate Ohio corporation that the defendants controlled) for the purpose of avoiding the Company’s creditors (the plaintiffs). The defendants began by changing Integra’s name and removing its website. Importantly, the defendants transferred the Company’s assets to another entity (BC4), planning to sell the worthless Company. By mid-2010, realizing that the judgments were inevitable, and unable to sell the business, the defendants decided to dissolve the Company before the plaintiffs could obtain default judgments. The Company’s board and stockholders authorized the dissolution. In connection with that dissolution process, however, the director defendants allegedly caused the Company to transfer all or substantially all of the Company’s remaining assets to the other business entity (BC4).

Plaintiffs  Pled Bancario‘s “Conspiracy Theory” of Jurisdiction

Plaintiffs argued that the Court may exercise personal jurisdiction over the non-consenting defendants because (1) the director defendants caused the Company to file a certificate of dissolution with the Secretary of State, which constitutes the transaction of business for purposes of the long-arm statute; and (2) that jurisdictional act can be attributed to the non-consenting defendants under the so-called “conspiracy theory” of personal jurisdiction recognized by the Delaware Supreme Court in the Istituto Bancario decision. Plaintiffs contended that all the defendants, including the non-consenting defendants, participated in a conspiracy to dissolve the Company. Further, according to the plaintiffs, because the director defendants filed a certificate of dissolution, their action should be imputed to the non-consenting defendants because the conspiracy involved a collective effort between all defendants.  

In discussing the relevant law regarding the plaintiffs’ personal jurisdiction claim, the Court explained:

[b]ecause the Long Arm Statute speaks in terms of acts committed “in person or through an agent,” and because “conspirators are considered agents for jurisdictional purposes,” “a foreign defendant may be subject to jurisdiction in Delaware, despite lacking direct forum contacts of its own, where it acts as part of a scheme in which the others engaged in Delaware-directed activity.”

The Court next explained that under the five-part test articulated in Bancario, a plaintiff asserting a conspiracy theory of jurisdiction must make a factual showing that:

 (1) a conspiracy to defraud existed; (2) the defendant was a member of that conspiracy; (3) a substantial act or substantial effect in furtherance of the conspiracy occurred in the forum state; (4) the defendant knew or had reason to know of the act in the forum state or that acts outside the forum state would have an effect in the forum state; and (5) the act in, or effect on, the forum state was a direct and foreseeable result of the conduct in furtherance of the conspiracy.

 Additionally, the Court stated, “Although Bancario literally speaks in terms of a ‘conspiracy to defraud,’ it is now well-settled that ‘a claim for aiding and abetting a breach of fiduciary duty satisfies the first and second elements of the Bancario test.” Next, the Court identified the elements of aiding and abetting a breach of fiduciary duty as the following: (1) a fiduciary relationship exists; (2) a breach of that relationship occurred; (3) that the alleged aider or abettor knowingly participated in the fiduciary’s breach of duty; and (4) damages exists that are proximately caused by the breach.

Conspiracy Jurisdiction Exists Over Integra

There was no dispute that a fiduciary relationship existed and the plaintiffs suffered damages; however, Integra denied that the plaintiffs pled a breach of duty against the director defendants or that Integra, the entity itself, as opposed to its directors– “knowingly participated” in the Company’s directors’ breach. The Court disagreed with Integra, stating:

Integra’s argument . . . deserves short shrift. . . . The Complaint alleges that the Director Defendant’s “breached their fiduciary duties by unlawfully dissolving [the Company] and engaging in a series of self-dealing and interested transactions . . . to the detriment of [the Company’s] creditors, including [the] plaintiffs.” That allegation is supported by the specific fact, among others, that [the Company] made preferential payments to Integra under the 2005 Management Services Agreement while insolvent and when Defendants feared that judgment creditors like [the] plaintiffs would have priority over Integra’s accounts receivable. These allegations state a claim for breach of fiduciary duty.

            . . .

 The flaw in Integra’s argument is that it mischaracterizes the alleged wrong as a conspiracy to dissolve [the Company]. Although dissolution of the Company was a substantial component of the alleged scheme to effect self-dealing transactions, the “conduct advocated or assisted constitut[ing the] breach” was the preferential treatment [the Company] gave to a subset of its creditors for self-interested reasons at a time when the Company was insolvent and, ultimately, planning to dissolve.  Hence, Plaintiffs only need to plead facts permitting an inference that Integra knowingly advocated or assisted the Director Defendants in giving Integra the alleged preferential treatment.

 The Court went on to state, “in the context of merger negotiations . . . while the acquirer’s mere receipt of preferential terms does not demonstrate participation in the target board’s breach of duty, ‘the terms of the negotiated transaction themselves may be so suspect as to permit, if proven, an inference of knowledge of an intended breach of trust.” The Court then noted that the alleged breach of duty in the case sub judice does not involve a negotiated merger, but disloyal preferential treatment to certain creditors.  However, “by analogous reasoning . . . the extent of preferential treatment to insider creditors also may be so suspect or egregious as to permit an inference of knowing participation in the breach of duty.”

The Court found that the plaintiffs satisfied the first two Bancario elements as to Integra based on: (1) the Company did not make payments to the plaintiffs under the 2005 Management Services Agreement for a period of almost three years; (2) Rosenberg, a director of the Company, “instructed”/”suggested” that Integra start formally documenting a payable from the Company to Integra as a secured note rather than an unsecured payable so that Integra could claim priority over any potential judgment creditors of the Company; (3) the suggestion to take down the website for the purpose of making it difficult for creditors to “track them down”; (4) the “brash attitude” in Rosenberg’s emails about managing the Company’s affairs solely and explicitly to undermine the plaintiffs’ ability to recover their then still prospective judgments and to advantage its affiliate Integra; (5) Integra knew that Company was insolvent because both of its directors served on Cubits Board and Integra provided day-to-day management services to the Company.

In regards to the third element of the Bancario test—that a substantial act or substantial effect in furtherance of the conspiracy occurred in the forum state—the Court found that the Company filing a certificate of dissolution with the Secretary of State was a substantial act in furtherance of the director defendants’ allegedly disloyal scheme to give preferential treatment to Integra.

Finally, “[t]he fourth and fifth . . . elements are that ‘the defendant knew or had reason to know of the act [or effect] in the forum states’ and that ‘the act in[, or effect on,] the forum states was a direct and foreseeable result of the conduct in furtherance of the conspiracy.” The Court found that both elements were satisfied because Integra is charged with the knowledge of its directors who authorized the Company’s dissolution. Moreover, the Court found the act of filing a certificate of dissolution to be a direct and foreseeable result of conspiring to dissolve the Company. Similarly, it was reasonable to infer that Integra, through the director defendants, knew of the preferential payments to Integra and that, as a result of those payments, the Company would be unable to afford comparable treatment to the plaintiffs, even though they were (or imminently would be) judgment creditors of the Company.

After finding that all five elements were satisfied, the Court held that its exercise of personal jurisdiction over Integra comports with constitutional due process.

Conspiracy Jurisdiction Does Not Exist Over BC2

The Court held that the plaintiffs failed to satisfy the first two Bancario elements because the plaintiffs’ pleading failed to state a claim of either aiding or abetting or civil conspiracy against BC2.

Conspiracy Jurisdiction Does Not Exist Over BCV

Similarly, the Court found that the plaintiffs’ basis for personal jurisdiction over BCV failed for the same reason as with BC2—as a result of the absence of nonconclusory allegations or evidence that BCV conspired or knowingly participated in an unlawful scheme to defraud the Company’s creditors. Except for conclusory allegations, there is no indication that BCV participated in any of the events that gave rise to the plaintiff’s various claims.  The Court went on to explain that the only specific allegations supporting the plaintiffs’ conspiracy theory of jurisdiction against BCV are that two of the alleged primary wrongdoers held management-level positions at BCV and BCV benefited from the allegedly fraudulent transfers. “More than mere knowledge, however, is required to subject a foreign corporation to the personal jurisdiction of this Court.” Rather, unless the plaintiffs “seek to predicate personal jurisdiction on a veil-piercing theory, they must identify some action by BCV, the entity, from which the Court can infer the requisite participation or conspiratorial agreement.”

Delaware Supreme Court Upholds Historic $2 Billion Judgment in Southern Peru Case

Prof. Paul L. Regan

 On Monday, August 27, 2012 the Delaware Supreme Court issued a 110 page opinion in which the Court upheld the decision of Chancellor Leo E. Strine Jr. awarding a judgment of more than $2 billion in damages in a shareholder derivative action on behalf of Southern Copper Corporation (formerly Southern Peru Copper Corporation (“Southern Peru”)) against its controlling shareholder Grupo Mexico (“Grupo”) and the directors on the board of Southern Peru who were affiliated with Grupo.  The $2 billion judgment, premised on a finding of a breach of the fiduciary of loyalty by Grupo and the Grupo affiliated directors on the board of Southern Pacific, is the largest award ever issued by a Delaware court.

 The case arose out of a controlling shareholder conflict transaction completed in 2005, originally proposed by Grupo, in which Southern Peru paid Grupo $3.7 billion in newly issued Southern Peru shares to acquire Grupo’s 99% stake in Minera Mexico (“Minera”).   Chancellor Strine found after trial that Grupo’s ownership stake in Minera was worth only $2.4 billion and that Southern Peru thus had overpaid Grupo by $1.3 billion.  With pre-judgment and post-judgment interest added to the $1.3 billion in transaction damages, the final judgment against the defendants was $2.031 billion.  The Supreme Court also affirmed the Chancellor’s decision to award 15% of this amount, or $304 million in attorneys’ fees, to counsel for the shareholder plaintiff, emphasizing under established Delaware precedent that the most important factor to consider on fee petitions in common fund cases is the size of the benefit obtained for the corporation or its shareholders.

 Grupo owed fiduciary duties to Southern Peru and its minority stockholders as the company’s controlling stockholder.  Grupo held 54% of Southern Peru stock, controlled 63% of its voting power and also had the right to nominate a majority of the Southern Peru board.  At the time of the Minera transaction, 7 of the 13 members of the Grupo board were affiliated with Grupo.  In a thorough and highly fact-intensive opinion, the Delaware Supreme Court sweepingly affirmed Chancellor Strine’s conclusion that Defendant Grupo and its affiliate directors failed to demonstrate the entire fairness of the Minera transaction to Southern Peru and its minority shareholders.  Indeed, the valuation evidence showed that the transaction was demonstrably unfair in this regard and thus could not withstand the strict judicial scrutiny that is the standard of review for such conflicted fiduciary transactions.

 The unprecedented size of the judgment in the case will certainly bring much attention to the decision, but there is really no new doctrinal ground plowed in this one.  Of most interest to this writer, and likely to transaction planners and litigants alike, is the Supreme Court’s discussion of the burden shifting analysis that applies to conflict transactions involving controlling shareholders.

 Long ago the Supreme Court in Weinberger v. UOP, Inc., 457 A.2d 701 (Del. 1983) ruled that strict judicial scrutiny, comprised of the now familiar entire fairness analysis which places the burden on the defendant to show fair dealing and fair price, was the proper standard of review for parent-subsidiary merger transactions.  In a transparent signal to transaction planners, the Weinberger Court suggested in a footnote that such conflict transactions could receive a more favorable welcome by the Delaware courts if a committee of the subsidiary’s independent directors were established to negotiate exclusively on behalf of the minority stockholders and thereby approximate an arm’s length transaction.   Id. at 709 n.7.  A decade later, in Kahn v. Lynch Communication Systems, Inc., 638 A.2d 1110 (Del. 1994) the Delaware Supreme Court clarified that the effective use of a special committee in a parent-subsidiary conflict transaction, though welcome, would not avoid the strict scrutiny standard of review applicable to such problematic transactions but would however earn the defendants a favorable shift in the ultimate burden of proof.  That is, assuming that a truly independent committee was appointed and then functioned effectively by approximating an arm’s length transaction (the Kahn committee, though independent, failed to function effectively by caving to the controller’s demands at the end of the process), the ultimate burden of proof on the merits – within the strict scrutiny standard of review – would shift thereby requiring the shareholder plaintiff to prove unfairness.  Kahn also clarified that such a shift in the burden of proof would apply if the controlling shareholder empowered the minority shareholders with a “veto” by conditioning the transaction on an informed and approving vote of a majority of the minority shareholders.

 The Southern Peru case decided this week directly addresses some important practical concerns that have remained since Lynch was decided nearly 20 years ago.  Why would a controlling shareholder go to the trouble of a special committee process when the litigation pay-off is seemingly a mere modest shift in the burden of proof but an otherwise continuing application of the entire fairness test?   Moreover, when cases go to trial in the Delaware Court of Chancery, don’t litigants need a trial strategy informed by what rules of law apply to their case?  But the burden shifting that Lynch makes possible will not be known in most cases until after all the witnesses have testified and long after the parties have submitted their post-trial briefs in which they will still be arguing about who has the ultimate burden of proof in the case.  Indeed the defendants in Southern Peru argued that such litigation uncertainty would dissuade corporations from forming independent committees in future transactions but the Supreme Court appropriately would have none of this flimsy claim.

 Since Lynch was decided controlling shareholders planning a conflict transaction haven’t formed special committees for a modest shift in the burden of proof.  They engage in such a process to win the day on the merits under the entire fairness analysis, irrespective of whether the burden of proof shifts from the defendants to prove fairness to the plaintiffs to prove unfairness.  Planning for trial in an entire fairness case means first planning a transaction process that accords with the expectations that Weinberger, Lynch and their progeny have established.  That means establishing a committee of genuinely independent directors to evaluate and/or negotiate a transaction with a controlling shareholder.  Once constituted, the committee must then function effectively to the satisfaction of the reviewing Court, which in the context of a conflict transaction will be appropriately skeptical and untrusting (i.e., will apply strict scrutiny).  Functioning effectively in turn means the committee must take on its responsibility as if it were engaging in an arm’s length negotiation and thus the committee must stand ready to reject any unacceptable proposals by the controlling shareholder and otherwise protect its independence from any influence or retributive threats (express or implied) of the self-interested controlling shareholder.

 At the end of the day, the Supreme Court in Southern Peru unabashedly acknowledged that such genuine practical concerns might be raised by a burden shift that cannot be known before trial, but the Court clarified in such cases going forward that the burden of persuasion would remain “with the defendants throughout the trial to show the entire fairness of the interested transaction.”  In this regard, the Supreme Court’s ruling is likely in keeping with the advice of counsel to controlling stockholders in such cases already, i.e., establish a special committee process that is unassailable but prepare for trial as if the burden of proof remains on the defendants.  For transaction planners and litigation counsel alike, Southern Peru appropriately reinforces the practical reality that defendants in these cases need to protect the transaction with good process irrespective of whether they get the burden shift before, at or after trial.

SEC Issues Order Granting First Whistleblower Award. However, the Dearth of Information Disclosed Provides Little Guidance for Practitioners.

This post is authored by Luke M. Scheuer, Assistant Professor of Law:

Last week, a host of online media sites reported that the Securities and Exchange Commission (the “SEC”) issued an order granting the first payment under a new whistleblower program authorized by the Dodd-Frank Act.  The program allows the SEC to reward whistleblowers who provide information that leads to sanctions of $1M or more.

The order and accompanying press release issued by the SEC are notable in that they provide virtually no information about the underlying case, and are therefore of little to no practical use to attorneys advising potential defendants or whistleblowers.  The SEC has an interest in protecting the identity of whistleblowers, as they provide information that allows the SEC to prevent and prosecute cases of corporate fraud.  If the identity of a whistleblower is revealed, it will naturally make future whistleblowers reluctant to come forward.  In addition, the SEC is prohibited under federal law from disclosing information that might reasonably reveal a whistleblower’s identity.  Thus, the SEC must balance the need to protect the anonymity of whistleblowers against the need for public disclosure and promotion of the program if it wants the program to be a success.

 Although the press release and order do not provide details of the underlying case, the press release states that the SEC has collected $150,000 in sanctions, and that the whistleblower has received a $50,000 award.  Under the program, the SEC can award anywhere from 10 to 30 percent of total sanctions collected.  By giving the whistleblower the highest possible monetary award of 30% in this case, the SEC seems to be sending a message that they are fully committed to the program and want to encourage other whistleblowers to come forward.  The whistleblower may receive an even larger award if the SEC is successful in collecting more in this case.

Although there are laws protecting whistleblowers against retaliation, their effectiveness is limited.  SEC Rule 21F-17 bars any person from taking “any action to impede an individual from communicating directly with the Commission staff about possible securities law violations.”  Nevertheless, if outed, whistleblowers will have a hard time remaining in their job, as colleagues will view them with suspicion.  The consequences of not protecting the whistleblower’s anonymity can be seen in the sad case of Peter Sivere who provided information to the SEC about his employer JPMorgan, only to have an SEC attorney inform JPMorgan of Sivere’s actions and provide JPMorgan confidential information received from Sivere that could be used in an employment action against Sivere. Despite the fact that the SEC admitted that its attorney had engaged in this conduct, in clear violation of SEC rules, the SEC decided to take no action against its attorney.  Sivere ended up being pushed out of his job by JPMorgan after it learned of his whistleblowing.  More can be read about the Sivere incident here. Perhaps, the lack of information in this recent whistleblower case is a necessary reaction to the Sivere incident.

Although whistleblower anonymity is critical to the success of the program, the lack of disclosure in this case is frustrating to practitioners advising potential defendants and whistleblowers. The SEC stated that the whistleblower “provided documents and other significant information that allowed the SEC’s investigation to move at an accelerated pace and prevent the fraud from ensnaring additional victims.” The SEC also denied an award to a second whistleblower because “the information provided did not lead to or significantly contribute to the SEC’s enforcement action.”  The order provides no other details that distinguish the two cases, or that might help attorneys advise their clients on the possibility they can collect an award for whistleblowing.  We know nothing about the timing of the tip, how crucial the whistleblower’s information was, or whether the whistleblower had clean hands for example.  Without this kind of information, attorneys cannot use the case as a basis on which to advise clients, whether whistleblowers or potential defendants, on where they are likely to fall within this program. This may be a necessary sacrifice for the reward program to work, but it seems to indicate a lack of faith in the effectiveness of whistleblower protection laws.

Synthes-is: Strine on Pro Rata Treatment in a Sale of a Company with a Controlling Stockholder

Should courts permit deal litigation to go forward when there’s no evidence that the sale process was rushed, or was tainted by an interest on the part of those influencing the process in favoring themselves at the expense of public shareholders generally?

In his typically colorful opinion in In re Synthes, Inc. Litigation (Aug. 17, 2012), Chancellor Strine says no, because facts matter. The overwhelmingly significant fact in the case, according to the Chancellor, was that the allegedly controlling stockholder (Wyss) would receive exactly what all other stockholders would receive, no more, no less. And speaking of no less, the Chancellor was adamant – and supported by long-standing case law – that the controller wasn’t obligated to pursue a partial bid for the company that might have given public stockholders a marginally better deal, perhaps, but would have required the controller to retain a significant equity interest in the continuing enterprise, and thus sacrifice the ability, available to public stockholders, to sell his entire holdings.

Two aspects of the opinion seem particularly notable. The first is probably dictum, because the opinion rejects the application of Revlon to the transaction at issue, in which the stock component represented 65% of the total consideration. But the Chancellor notes that “even if Revlon applied, … there are no pled facts from which I could infer that Wyss and the Board did not choose a reasonable course of action to ensure that Synthes stockholders received the highest value reasonably attainable.” This is a powerful statement, and a welcome one. In particular, it is a useful reminder that the application of Revlon does not dispense with the requirement that a complaint adequately allege a breach of the fiduciary duties implicated in that case. Nor does Revlon’s application preclude dismissal simply because the transaction includes what are widely recognized as standard deal protection measures (3% breakup fee, no-solicitation provision with fiduciary out, and matching rights).

The second notable aspect of the opinion also bears on the question of dismissing deal litigation at the pleading stage. The plaintiffs’ main theory for applying the entire fairness standard was the notion that the controller’s interest in liquidity created a conflict in relation to the public stockholders, for whom a potentially higher bid would be preferable even though it would deny the controller the full liquidity he desired and that the public stockholders would have. According to the opinion, and most remarkably, plaintiffs did not rely “in any way” on McMullin v. Beran, 765 A.2d 910 (Del. 2000). Perhaps because of that, the Chancellor addresses that opinion only in a footnote, albeit an extended one. That footnote (fn. 91) bears close reading, because I would have thought that plaintiffs would have relied extensively on McMullin. As the Chancellor explained, that opinion might have assisted the plaintiffs in Synthes because “the Supreme Court accepted the contention that a duty of loyalty claim could be filed against the parent for negotiating an ‘immediate all-cash [t]ransaction’ to satisfy a liquidity need by accepting as true the plaintiff’s allegation that the full value of the subsidiary “might have been realized in a differently timed or structured agreement.” Id. at 921.

The Chancellor’s footnote, however, closely questions the financial reasoning implicit in McMullin:

McMullin seems to contemplate that that it was disloyal for the controlling stockholder to accept an all-cash deal in part because a ‘differently … structured’ deal (e.g., a stock-for-stock deal) ‘might have’ delivered more shareholder value, but the controller accepted a lower-valued all-cash deal because of its need to use that cash to fund an acquisition of a separate company. McMullin, 765 A.2d at 921. But, this reasoning glosses over the reality that the present value of stock depends on the currency value into which it can be converted, plain and simple.

Appropriately enough, the Chancellor recognizes in Synthes that a controller’s interests could in some case inappropriately conflict with the interests of public stockholders, even where the deal consideration is shared pro rata:

It may be that there are very narrow circumstances in which a controlling stockholder’s immediate need for liquidity could constitute a disabling conflict of interest irrespective of pro rata treatment. Those circumstances would have to involve a crisis, fire sale where the controller, in order to satisfy an exigent need (such as a margin call or default in a larger investment) agreed to a sale of the corporation without any effort to make logical buyers aware of the chance to sell, give them a chance to do due diligence, and to raise the financing necessary to make a bid that would reflect the genuine fair market value of the corporation. In those circumstances, I suppose it could be said that the controller forced a sale of the entity at below fair market value in order to meet its own idiosyncratic need for immediate cash, and therefore deprived the minority stockholders of the share of value they should have received had the corporation been properly marketed in order to generate a bona fide full value bid, which reflected its actual market value.

But the lesson of Synthes, as I see it, is that a complaint should do more than speculate about possible inconsistency of interests between controller and public: to survive a motion to dismiss, it should lay out facts indicating in some reasonably specific way why it is conceivable that such an inconsistency actually exists.

Insurer Standing in the Ninth Circuit—Focusing Solely on the Express Terms of the Debtor’s Reorganization Plan

This post is authored by Peter Tsoflias, Widener Law School Class of 2013:

Section 524(g) of the United States Bankruptcy Code purports to provide relief to debtors facing waves of asbestos, silica, benzene and other mass tort related claims. To be sure, section 524(g) allows Chapter 11 debtors to establish a trust and an injunction which channels present and future mass tort claims to the trust. As would be expected, liability insurance is often the primary asset funding such trusts. Due to the fact that insurers are affected by reorganization plans encompassing section 524(g) trusts, affected insurers often seek to challenge the confirmation of such plans.

In order to challenge the confirmation of a reorganization plan, an insurer must meet the standing requirements prescribed by the Constitution as well as the Bankruptcy Code. The Third Circuit’s jurisprudence is fairly well developed with respect to the issue of insurer standing in the bankruptcy context. To this effect, the Third Circuit first dealt with insurer standing in In re Combustion Engineering. After closely examining the reorganization plan at issue, the Combustion court noted that the plan adequately preserved the insurers’ pre-petition contractual rights and defenses; therefore, the plan was deemed “insurance neutral”. In so noting, the court held that the insurers faced no injury by the plan and, consequently, did not have standing to challenge the plan’s confirmation.

Subsequent Third Circuit decisions followed suit—closely examining each reorganization plan at issue to determine whether each plan’s language was insurance neutral. In a prior writing (found here), I took issue with the Third Circuit’s most recent holding concerning insurer standing in the bankruptcy context—In re Global Industrial Technologies (hereinafter “GIT”).

The debtors in GIT sought bankruptcy relief in order to address over 235,000 asbestos related claims and 169 silica related claims then pending against the debtors. The debtors’ plan, which included a section 524(g) trust, purported to preserve the insurers’ pre-petition rights and defenses post-confirmation (i.e., insurance neutrality language). Despite the plan’s insurance neutrality language, the Third Circuit reversed the lower court decisions and held that the insurers had standing to challenge the plan’s confirmation. Notably, the court did not base its holding on whether the debtors’ plan adequately preserved the insurers’ rights and defenses. Rather, the court focused on the “suspect circumstances” surrounding the silica claims. In particular, the Third Circuit found that the number of silica claims surged shortly after the debtors filed bankruptcy. The court found these claims to be “suspect” because they were allegedly products of collusion between the attorneys representing the asbestos and silica claimants. The Third Circuit held that investigating these suspect claims created a new class of administrative expenses that the insurers would be called to bear. Such an increase in administrative expenses increased the insurers “quantum of liability”, therefore constituting an injury sufficient for bankruptcy standing.

In my Note, Insurance Neutrality: Affecting an Insurer’s Right to Bankruptcy Standing, (see link above) I sided with the GIT dissent, arguing that the Third Circuit should not have focused on any increase in the insurers’ “quantum of liability.” Doing so frustrates the intent of the Bankruptcy Code and undermines basic principles underlying contract and constitutional law. Further, I articulated a two prong test for courts to apply when addressing the issue of insurer standing in the bankruptcy context. First, as a threshold matter, courts should determine whether the plan at issue adequately preserves insurer’s pre-petition rights and defenses (i.e., includes insurance neutrality language). In making this determination, courts should not look beyond the four corners of the plan (as the court did in GIT). Second, courts should determine whether the plan at issue threatens to undermine the integrity of the bankruptcy court. If this is found, a more searching look into the plan’s validity is warranted. This standard serves several objectives (as discussed in my Note)—most notably, it is in agreement with basic contract principles. To this end, I argue that if a plan adequately preserves an insurer’s pre-petition rights and defenses (as was the case in GIT) the insurer suffers no contractual injury. By granting an insurer standing in this context (as the Third Circuit did in GIT), the court is giving an insurer more rights than the insurer initially bargained for.

Despite the Third Circuit’s “quantum of liability” standard set forth in GIT, the Ninth Circuit in In re Thorpe Insulation Co. solely examined the express terms of the plan at issue. Similar to the plan in GIT, the debtor’s reorganization plan in Thorpe contained a section 524(g) trust and a provision stating that the plan is “insurance neutral” because it preserves all “Asbestos Insurance Defenses.” Notwithstanding this boilerplate language, the debtor’s plan contained four exceptions to the insurers’ otherwise preserved defenses. In light of these exceptions, the court held that the plan was not insurance neutral because it did not adequately preserve the insurers’ pre-petition contractual rights and defenses. Accordingly, the insurers were granted standing to challenge the plan’s confirmation.

The Ninth Circuit’s holding in Thorpe is consistent with the two prong test articulated in my prior Note. In particular, by focusing solely on the express terms in the debtor’s plan and the contract between the debtor and its insurers, the Ninth Circuit’s analysis was in accord with basic contract and constitutional principles. In order to promote consistency, reliability and efficiency in bankruptcy proceedings, courts should welcome the Ninth Circuit’s approach to analyzing the issue of insurer-standing. Two thumbs way up for the Ninth Circuit!

Certifying questions of law from bankruptcy courts to the Delaware Supreme Court

Under Article IV, Section 11, paragraph 8 of the Delaware State Constitution, the Delaware Supreme Court can entertain and respond to certified questions of law from federal district and appellate courts, and state supreme courts, as well as the Securities and Exchange Commission. For now, however, bankruptcy judges aren’t able to engage in that certification process.

At a conference held at Widener on April 16, however, a panel of state court and bankruptcy court judges tossed around the idea of enabling bankruptcy courts to certify questions of Delaware law to the Delaware Supreme Court. The judges’ reaction, from both sides of the federal/state line, was quite positive. And it looks as if the idea may be on the way to becoming law: Senate Bill 221, introduced in the Delaware General Assembly on May 16, would if adopted be the first step in amending the State Constitution to implement the idea. If adopted in this legislative session ending June 30, it would need to be re-adopted next year by the newly elected General Assembly, in order to become effective.

Celera and class action standing

A recent blog entry (“Delaware Chancery Court Chides Pension Fund for Boosting Returns”) discussed the March 23, 2012 Chancery opinion in the Celera case that didn’t get much attention when it came out. [See also Francis Pileggi’s blog entry]. I’m told that the case is on appeal now, however, and it may get a great deal more play going forward.

The blog quoted me (fairly, I might add) as questioning why the opinion was so critical of the plaintiff’s sale of its shares shortly before the challenged acquisition’s second step merger. I suggested that the plaintiff’s obligations to its own beneficiaries may have justified or even compelled that sale, and that it didn’t make a lot of sense to force a plaintiff to forego such a sale in order to maintain status as class representative.

As they say, however, it’s complicated. I still don’t see why the plaintiff’s sale ought to be viewed darkly, as an inequitable manipulation unsuited to its fiduciary status. That sort of criticism doesn’t in my view adequately acknowledge the plaintiff’s institutional obligations as a money manager. Thus, the Vice Chancellor’s ruling that the plaintiff was not barred by the doctrine of acquiescence, given that the transaction was a “fait accompli,” seems perfectly reasonable to me.

The problem, however, is that it’s unclear whether or how a stockholder who neither tenders in a first step offer nor is forced to sell in a second step merger — but who sells in the market in between those two events — could participate in any recovery on behalf of the class, which is usually defined as those who tender and those whose shares are acquired in the second step merger. And if the plaintiff doesn’t fit in either subgroup and wouldn’t be entitled to share in any recovery, can it properly represent those stockholders who would be entitled? And if it can’t, does its position as a class representative, once that mantle is seized, require it to forego a sale opportunity that its obligations to its beneficiaries might otherwise require it to pursue?

There’s an argument that the plaintiff’s sale in the market was at a price that necessarily reflects the value of the class claim, and therefore market sellers shouldn’t be entitled to participate in the class, because they reap the benefit of the litigation claims when they sell in the market. If that premise is correct, then there’s good reason to argue that the plaintiff, having asserted the right to act as a class representative, should have awaited the outcome of the litigation rather than obtaining the present-value benefit of selling in the market. That’s also a good reason for limiting the class to those who sell in the first step offer or the second step merger, but excluding those who sell in the market in anticipation of either part of transaction.

But what if the market doesn’t perfectly value pending claims? Are market sellers adversely affected by the anticipation of challenged transactions? If so, should they have standing to pursue fiduciary duty claims against such transactions? And if so, what practical means could be used to evaluate how to allocate amounts paid in settlement or judgment among those who sell in the market and those who sell in the challenged transaction itself?

Valuation Standards in Appraisal Proceedings — a Reply to Steve Bainbridge

Steve Bainbridge was a good sport, as usual, and shared with me his recent comments on DGCL § 262(h)’s exclusion of value arising from the accomplishment or expectation of the merger. I sent him a few reactions, more or less as set forth below:

1. You say “I have always assumed that Weinberger thus allowed the chancery court to consider evidence of, among other things, control premia paid in comparable acquisitions.” As Professor Wachter and I approach it (I think our most recent article — 50 B.C. L. Rev. 1021, 1038, 1052-53 — does a better job of explaining all this), we see it differently: control has a distinct value to the person who owns or acquires it, and it cannot be viewed as belonging to dispersed public shareholders or minority shareholders. Accordingly, and in light of the statutory exclusion, and UOP’s ambiguity notwithstanding, we believe that it’s a mistake to appraise fair value under the Delaware appraisal statute by reference to transactions that reflect payment of a premium for control.

2. You also say that “The real issue, after all, ought to be whether the dissenting shareholders received a fair premium over market. In order to answer that question, one must start with the price paid in the merger and, if appropriate, work up from there.” Again, we would respectfully disagree: for one thing, and as we point out in our most recent article (50 B.C. L. Rev. at 1034), most appraisal cases arise where there is no meaningful market for the shares being appraised. We also doubt that share prices in efficient markets necessarily and systematically yield prices below “fair value,” measured by the “going concern value” standard.

3. You ask “given that appraisal is now a crap shoot in which one can end up with less than the price offered in the merger, why would any sane investor invoke appraisal rights?” Preliminarily, this isn’t the first time that an appraisal award has been less than the merger consideration. I’m too lazy to dig out earlier examples right now, but it’s definitely happened before. Anyway (and don’t blame Wachter for this opinion), I think the far greater obstacle to appraisal as a useful remedy are the procedural hurdles (opt in, no $$ until the bitter end) rather than the substantive valuation standards, which have given quite a few shareholders a real and surprising boon (windfall?).

4. Finally, you say “Likewise, the policy of giving dissenting shareholders a fair price for their shares calls for taking synergistic elements into account, while the policy of giving the shareholders the fair value of their stock in the company as a going concern calls for excluding such elements.” We’re with you 100% on the second part of this sentence, and we think that’s the governing legal rule. Again, though, we would disagree with the first half of the sentence: disaggregated shareholders don’t have control, and fairness doesn’t require that they be paid for what they don’t own.

And just a quick update: Steve’s response to this post asks how one can distinguish between future value permissibly taken into account in determining “fair value” from future value that is synergistic and disqualified for consideration. Here’s what I wrote back to him:

Fair question — I’ve always conceived of UOP’s principal contribution as overcoming a long held (and not altogether closely reasoned) antipathy to use of projections. In short, no DCF before UOP; post-UOP, practically always used. Future value encompasses the range of opportunities available to the stand-alone firm, and value of the future returns associated with those opportunities (as long as they’re not “speculative,” whatever that means — not reasonably foreseeable?). But the key words are “available to the stand-alone firm” — once the opportunity for future returns depends on a combination with a merger partner (i.e. is a synergistic value), that’s when I think 262(h) operates to require excluding any additional value associated with that opportunity.

Thanks for the opportunity to put off some more grading.

And here’s some more explanation from my co-author Professor Wachter:

Let me add to Larry’s remarks. In Corporate Finance (at least the finance of corporate finance) we teach that the value of the firm is the value of the discounted free cash flows of its current assets plus the PVGO (present value of future growth opportunities). The PVGO, particularly for firms in appraisal is often the larger of the two. I think of it as the corporation’s existing corporate policy which normally includes several years of continuing investments. The more specific the existing corporate policy, the more likely that the petitioner can get those values included in the appraisal. The respondent can question the value of these future opportunities, but they do indeed belong to the corporation at that time. These opportunities are distinct from synergies resulting from a merger. I use the stock market’s valuation of Amazon as an example. That company’s valuation is mostly the present value of future growth opportunities.

Proxy Access Votes – 2012

Here’s a scorecard for those interested in how proxy access shareholder proposals fared in their first season (the ISS corporate governance blog has already reported some of this information, as has Francis Byrd of Laurel Hill Advisory Group, in his wonderfully titled “Byrd-Watch” page, but the numbers here are a little more comprehensive):

Download the Excel .xls version: 2012 proxy access votes

Grains of salt are in order: the sample is small (a total of nine access proposals were presented for a vote this year); in the case of KSW, moreover, the company had already adopted a proxy access bylaw (with a 5%/1 year ownership minimum). Still, and with two notable exceptions discussed below (Nabors and Chesapeake Energy), the voting was not a ringing shareholder endorsement of proxy access in any and all forms.  Apart from those two exceptions, the 2012 votes in favor of proxy access have been below 40% of the shares voting, below 35% of shares present, and below 30% of shares outstanding.

The two exceptions, however, were at Nabors Industries and Chesapeake Energy, where the access proposal garnered approval of a majority of the shares voting and of the shares present at the meeting, and substantial minorities (39.6% and 44.5%) of the outstanding shares.  What might explain these notable successes?  One possibility is both Nabors and Chesapeake had been the subject of high-visibility questions about executive compensation and related party transactions involving their CEOs, including the controversy surrounding the $100 million severance payment (subsequently waived) to the former CEO. Another possibility is that the Nabors and Chesapeake access proposals were the most restrictive of this year’s crop, with a 3%/3 year ownership requirement mirroring the framework of the SEC rule (14a-11) struck down last year. It will be interesting, in any event, to see how the Nabors and Chesapeake boards of directors respond to the favorably shareholder votes.