CSG Corporate & Securities Insights Q1 | 2019
CSG’s Corporate & Securities Group is pleased to provide the latest installment of Insights – which highlights recent news, activities, judicial decisions, legislative actions and regulatory announcements of interest.
Edward B. Stevenson was recognized for his outstanding client service by BTI Consulting Group Inc. in its BTI Client Service All-Stars 2019 report. Notably, Ed is one of only 335 attorneys globally – and one of 10 in New Jersey – selected for recognition this year. For more information, click here.
CSG is pleased to announce that Clem G. Turner has been named to EB-5 Investors Magazine’s list of “Top 15 Corporate EB-5 Attorneys,” which recognizes the most influential corporate and securities law practitioners in the field of EB-5 finance. For more information, click here.
16 CSG attorneys have been selected for inclusion in the 2019 edition of New Jersey Super Lawyers, including corporate attorneys David M. Hyman and Edward B. Stevenson. Additionally, 9 CSG attorneys were selected for inclusion in this year’s edition of New Jersey Super Lawyers – Rising Stars. For a full list of CSG honorees, click here.
On February 27, 2019, CSG hosted Gregory A. Stoeckle, Co-Head and Senior Managing Director of Invesco Private Capital, for a discussion examining institutional capital’s unprecedented shift away from public markets.
Upcoming and Recent CSG Attorney Activities
Cybersecurity Panel – What Should Keep You Up at Night (May 22, 2019)
Judicial Decisions, Legislative Actions and Regulatory Announcements
Side Letter Missing Incorporation Provision
The New Jersey Appellate Court recently interpreted a side letter agreement among parties that were also parties to a Shareholder Purchase Agreement to determine whether disputes under the side letter were subject to arbitration. The court found, among other things, that the side letter failed to incorporate the terms of the Shareholder Purchase Agreement, which contained a binding arbitration provision, and thus, the parties’ dispute arising under the side letter was not required to be arbitrated.
In Estate of Noyes v. Morano, Noyes purchased shares of stock in defendant Morano’s company Cyber Technology, Inc. (“Cyber“) pursuant to a Shareholder Purchase Agreement containing certain stock restrictions, providing that Noyes could purchase additional Cyber shares and requiring that any dispute between the parties relating to the Shareholder Purchase Agreement be arbitrated.
Noyes and Cyber subsequently entered into a letter agreement wherein Noyes granted Cyber $150,000 to invest in the stock market. That letter agreement incorporated the terms of the Shareholder Purchase Agreement. The parties then entered into two subsequent letter agreements, which made no reference to the first letter agreement or the Shareholder Purchase Agreement (the “Cyber Letter Agreements”).
Noyes sued defendant for its failure to return Noyes’s invested capital pursuant to the Cyber Letter Agreements and defendant filed a motion to compel arbitration in accordance with the Shareholder Purchase Agreement. The court found that the parties were not obligated to arbitrate their dispute because (1) the Cyber Letter Agreements were “consumer contracts” because Cyber agreed to provide investment services to Noyes, and thus, the arbitration provision must have contained a clear waiver of rights to bring a claim in a court of law; and (2) the Cyber Letter Agreements did not expressly incorporate by reference the arbitration provision contained in the Shareholder Purchase Agreement.
Delaware Chancery Court Finds That Company’s Bylaws Provide Agent Mandatory Indemnification
In Pasternack v. Northeastern Aviation Corp., No. 12082-VCMR (Del. Ch. Nov. 9, 2018), the Delaware Court of Chancery (the “Court”) awarded indemnification for legal expenses and fees-on-fees (i.e., recovery of the costs associated with making a demand for indemnification) to Fred Pasternack (“Pasternack”), a pilot for Northeastern Aviation Corp. (“Northeastern”), under Northeastern’s bylaws because he was found to be an agent of Northeastern during his participation in a company-mandated drug testing program to maintain his pilot certification.
Northeastern is a charter flight operator that provides corporate jets with pilots and certain on-board business equipment. Pasternack, who is also a medical physician, served as an on-demand pilot for Northeastern, a position classified as an independent contractor. To maintain the Company’s compliance with applicable Department of Transportation and Federal Aviation Administration (“FAA“) regulations, Northeastern requires all pilots (including on-demand pilots) to comply with the company’s drug testing program. Pasternack was randomly selected and Northeastern required him to appear for a mandatory drug test. He was initially unable to produce a sufficient sample and after waiting some time, he informed the laboratory technician he had to leave to make an appointment with a patient of his medical practice, but that he would return later to complete the test. Pasternack returned later that same day and passed the drug test without incident. The laboratory technician, however, determined that Pasternack refused to take the initial drug test by leaving before it was completed, resulting in an automatic failure.
As a result of the failed drug test, the FAA revoked Pasternack’s pilot license. Pasternack challenged the revocation and the Court of Appeals for the D.C. Circuit ruled in his favor finding that there was insufficient evidence to determine whether the laboratory technician provided him with permission to leave the initial drug test. On October 20, 2015, Pasternack sought indemnification from Northeastern under the company’s bylaws for $140,000 in legal fees and expenses he incurred in connection with the proceedings to reinstate his pilot license. When Northeastern failed to substantively respond, Pasternack filed the instant suit.
In its decision, the Court noted Northeastern must indemnify Pasternack under its mandatory indemnification bylaws provision which states that “[t]he corporation shall indemnify its officers, directors, employees and agents to the extent permitted by the General Corporation Law of Delaware.” Section 145(a) of the Delaware General Corporation Law (“DGCL”) establishes the requirements for indemnification by a corporation. It provides:
A corporation shall have power to indemnify any person who was or is a party … to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative …by reason of the fact that the person is or was a director, officer, employee or agent of the corporation, … against expenses (including attorneys’ fees) … actually and reasonably incurred by the person in connection with such action, suit or proceeding if the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to the best interests of the corporation…
In citing Section 145(a) of the DGCL, the Court explained that the evidence must show that (1) Pasternack was a party to an action, suit, or proceeding by reason of the fact that he was a director, officer, employee, or agent of Northeastern; (2) the action, suit, or proceeding was brought neither by nor in the right of the corporation; (3) he actually and reasonably incurred legal expenses in connection with the action, suit, or proceeding; and (4) he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the corporation.
The parties disputed three key elements: (1) whether Pasternack was an agent of Northeastern; (2) whether Pasternack’s participation in the underlying FAA proceedings was by reason of his affiliation with Northeastern; and (3) whether Pasternack acted in good faith and in a manner not opposed to the best interests of the corporation. In ruling for Pasternack, the Court determined Pasternack was an agent of Northeastern at the time of the drug test, rejecting Northeastern’s argument that he acted as an agent only when he was piloting a flight. The Court also found that Pasternack appeared for the drug test at the direction of Northeastern and he did not act in a manner opposed to Northeastern’s best interests when he left the initial drug test, noting that his challenge to the FAA’s revocation and his subsequent exoneration protected the reputation of Northeastern. The Court ruled that in addition to his indemnification claim, Pasternack was also entitled to attorney fees he incurred in obtaining the instant ruling.
This case underscores the importance of a company’s bylaws and the attention that must be given to certain provisions, in this case the indemnification provision, when drafting.
SPOTLIGHT: ALTERNATIVE CAPITAL
From EB-5 investments to Qualified Opportunity Zone funds, we believe that clients who are eligible for low-cost capital should be able to utilize it with confidence. CSG’s Alternative Capital Group works closely with providers of capital and those tapping into innovative funding sources to help achieve their business goals while ensuring legal and regulatory compliance.
To learn more about our Alternative Capital Group, click here.
Books and Records Request Must Be Related to a Proper Purpose
The Delaware Court of Chancery granted in part and denied in part an LLC member’s request to compel the production of certain books and records from the company under Section 18-305 of the Delaware Limited Liability Company Act. (Durham v. Grapetree, LLC, Civil Action No. 2018-0174-SG (Del. Ch. Jan. 31, 2019). The subject of the Durham case is a rental property held in an LLC, which is owned by five siblings, all of whom are manager-members of the LLC except Andrew, the sibling-member who brought the suit to compel the production of books and records of Grapetree, LLC. The Court noted that the relationship of the siblings was hostile, and Andrew had made similar books and records requests in prior proceedings.
Under Section 18-305 of the Delaware Limited Liability Company Act (which functions in the same manner as Section 220 of the Delaware General Corporation Law), a plaintiff must establish a proper purpose for conducting an inspection of the books and records of a company. Section 18-305 states that such proper purposes permit an LLC member to obtain: “(1) true and full information regarding the status of the business and financial condition of the limited liability company; (2) promptly after becoming available, a copy of the limited liability company’s federal, state and local income tax returns for each year; (3) a current list of the name and last known business residence or mailing address of each member and manager; (4) a copy of any written limited liability company agreement and certificate of formation and all amendments thereto, together with executed copies of any written powers of attorney pursuant to which the limited liability company agreement and any certificate and all amendments thereto have been executed; (5) true and full information regarding the amount of cash and a description and statement of the agreed value of any other property or services contributed by each member and which each member has agreed to contribute in the future, and the date on which each became a member; and (6) other information regarding the affairs of the limited liability company as is just and reasonable.” 6. Del. C. § 18-305. Once the threshold of determining a proper purpose is met, the court balances the interest of the company with those of the member requesting to inspect the company’s books and records.
In Durham, Andrew provided numerous reasons for his requests to inspect Grapetree, LLC’s books and records, including to better understand why the business is failing, whether there is fraudulent bookkeeping, and whether the assets of the LLC are being properly administered. The Court denied many of Andrew’s requests, except those in furtherance of investigating wrongdoing on the part of the managers in support of his derivative action and the valuation of his interest which it deemed a “proper purpose.” In furtherance of Andrew’s proper purpose, the Court allowed him access to documents showing the tenants of the property for the past three years and rental amounts generated from such tenants, copies of client checks cashed by two of the manager-members, and Grapetree LLC’s “business plan” for the upcoming two years (to the extent that the business plan is an existing corporate document and would not need to be created to meet such request).
The Durham case clarifies that books and records requests must be related to a proper purpose of the requestor, and even if such proper purpose is articulated, the request must not be so onerous on the company as to cause the company to create new documents or cause disproportionate disruption to the company.
Delaware Court Upholds Rent-A-Center’s Termination of Merger with Vintage Capital Management, LLC
In Vintage Rodeo Parent LLC et al. v. Rent-A-Center Inc., C.A. No. 2018-0927 (Del. Ch. Mar. 14, 2019), Rent-A-Center gave notice to terminate its $1.36 billion merger deal with Vintage Capital Management, LLC (“Vintage Capital”). The parties executed the merger agreement on June 17, 2018, subject to regulatory approval by the Federal Trade Commission (“FTC”) via a Hart-Scott-Rodino Act (“HSR”) filing since the transaction parties were competitors. The merger agreement stated that the merger would become effective at such time that a certificate of merger was filed with the Delaware Secretary of State, or at such later time if specified in the certificate. Given the regulatory approvals and further steps needed to consummate the merger, the merger agreement also provided for an “End Date” of the deal, providing that if the deal was not approved by December 17, 2018 at 11:59 P.M. Eastern Time (the “End Date”), then either party could give notice and terminate the deal at will. Either party could also elect to extend the End Date.
At a meeting of the Rent-A-Center Board of Directors (the “Board”) prior to the End Date, the Board decided not to elect to extend the End Date, as the Board was convinced that Vintage Capital would extend the End Date. The Board also determined that if Vintage Capital did not elect to extend the End Date, Rent-A-Center would terminate the deal. When Vintage Capital did not extend the End Date, Rent-A-Center acted as planned and terminated the merger agreement. Vintage Capital sued Rent-A-Center claiming, among other things, that: (1) Vintage Capital and Rent-A-Center took numerous actions during the six months following execution of the merger agreement toward regulatory approval and that these actions and the accompanying documents executed by Rent-A-Center made clear the parties’ intent to close the merger after the End Date; and (2) Rent-A-Center acted fraudulently by concealing its intent to not extend the End Date, and waiting for Vintage Capital to miss the extension.
The Court found that Rent-A-Center did not act inconsistently with its intent to terminate, but rather that it used commercially reasonable efforts to obtain FTC approval and close. The Court also found that Rent-A-Center did not conceal the notice requirement from Vintage Capital, and did not breach its obligation to use commercially reasonable efforts to close the deal. The Court stated that Vintage Capital’s breach claim amounted to asking the Court to impose a “duty to warn” requirement on Rent-A-Center. In summary, the Court read the plain language of the termination provision concluding that, as a matter of contractual interpretation, it would refrain from writing a provision into a contract—such as requiring Rent-A-Center to notify Vintage Capital of the extension period—when it was clear the parties thoroughly negotiated the merger agreement and could have included such provisions themselves if so desired.
Delaware Court of Chancery Places Limits on Charter Forum Selection Clauses
In a recent decision, the Delaware Court of Chancery struck down charter provisions requiring claims under the Securities Act of 1933 to be filed in federal court. The Court noted that “Delaware can use its corporate law to regulate the corporation’s internal affairs.” However, “[t]he constitutive documents of a Delaware corporation cannot bind a plaintiff to a particular forum when the claim does not involve rights or relationships that were established by or under Delaware’s corporate law.” The Court determined that a claim under the Securities Act of 1933 is “external to the corporation” and “[u]nder existing Delaware authority, a Delaware corporation does not have the power to adopt in its charter or bylaws a forum-selection provision that governs external claims.”
Matthew Sciabacucchi v. Matthew B. Salzberg et al., C.A. No. 2017-0931-JTL (Del. Ch. Dec. 19, 2018)
For more information on this issue of Insights, please contact your CSG attorney or one of the members of the Corporate & Securities Group.