Delaware California Corporate Law Updates...• The company’s shares are not listed or traded on a national exchange – Potential impact of “quasi-California” status: • Stockholder

Delaware and California Corporate Law Updates

NEWPORT BEACH I DENVER I RENO I SACRAMENTO I SAN DIEGO I SAN FRANCISCO I SANTA BARBARA I SANTA MONICA I SEATTLE

Prepared for:

Corporate Counsel Roundtable

October 12, 2017

Delaware Law

o Why Delaware Matters

o Consenting to Delaware Law and Jurisdiction

o Stockholder Written Consents Developments

o Ratification of Defective Corporate Acts

o Preferred Stock Issues

o Fiduciary Duty Case Law Developments

o Blockchain Technology Developments

California Law

o Filing Form Updates

o Electronic Signatures

o California Revised Uniform Limited Liability Company Act

o Fiduciary Duties of Controlling Shareholders

o Inspection of Records

o Contract Drafting Updates

OVERVIEW

Delaware Law Update

Why Delaware Matters Jurisdiction of Choice for Entity Formation

– 1.22 million active entities • 298,000+ Corporations (39,598 formed in 2016)• 827,000+ LLCs (129,852 formed in 2016)

– 66%+ of publicly traded US companies– 66%+ of Fortune 500– 87% of US IPOs– 176 Unicorns – 927 Public Benefit Corporations

Why Delaware is the Jurisdiction of Choice– Business entity statutes are modern, stable and flexible

• “enabling” statute• annually reviewed by corporate bar; regularly updated to take into account business and

case law developments – Well developed body of case law – fiduciary duty is judge-made common law– Sophisticated courts with expertise in corporate and commercial matters

• Court of Chancery – considered nation’s leading business court• Superior Court – Complex Commercial Litigation Division

– User-friendly Secretary of State Division of Corporations

Consenting to Delaware Law and Jurisdiction Delaware law applies to business entities formed in Delaware

– The “Internal Affairs Doctrine” • Law of jurisdiction of formation of corporations, LLCs, partnerships and other

business entities governs “internal” legal and equitable matters – e.g., corporate powers, stockholder rights, fiduciary duties

• Delaware law governs LLC agreements, partnership agreements, and voting agreement

Contracts may provide that they are to be governed by Delaware law– Commercial and contract law are matters of state law – but which state?

• Restatement (Second) of Contracts – parties may select by contract which state law applies to their contract unless the chosen state has “no substantial relationship to the parties or the transaction” or contrary to fundamental policy of state with materially greater interest

• Delaware choice of law statute – 6 Del.C. 2708 – choice of Delaware law will be enforced (presumed significant, material and reasonable relationship) if parties are subject to jurisdiction, and may be served with legal process, in Delaware, and contract involves at least $100,000.

Certain California statutes override of the internal affairs doctrine:– Cal. Corp. Code Section 2115 – certain provisions of Cal. Corporations Code

govern companies incorporated in other states if:• More than half of the company’s voting stock is held by California

residents• The company conducts a majority of its business in California, and• The company’s shares are not listed or traded on a national exchange

– Potential impact of “quasi-California” status:• Stockholder class vote requirements for certain corporate actions• Cumulative votes in election of directors• Limits on distributions to shareholders• No business judgement rule protection for officers

– Delaware Supreme Court ruled that Cal. Corp. Code 2115 is unconstitutional due to extraterritorial reach. Vantagepoint Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108 (Del. 2005)

Consenting to Delaware Law and Jurisdiction

CA Courts Do Accept Internal Affairs Doctrine – In Saratoga Advantage Trust Technol. & Communications Portfolio v Marvell

Technol. Group (ND Cal, Aug. 16, 2016, No. 15-cv-04881-RMW), a CA court ruled that rights of shareholders are determined by the law of the place the company is incorporated when there are claims for breaches of fiduciary duties by a Board of Directors (and CA 2115 does not apply)

Public Policy Considerations– California also weighs whether there is a fundamental policy of CA that

would be violated by applying a separate state law (such as Delaware law).

• If a conflict exists, and a CA court needs to make a decision, the courtwill determine whether the state has a materially greater interestthan the selected jurisdiction when determining enforceability of choiceof law provision.

• Most often, this applies in claims of violations of securities cases (vsfiduciary duty arguments) and employment related disputes (non-competition arrangements, reciprocity of attorney fees).


Apply Delaware law (and not California) –Through Litigation in Delaware

Personal and Subject Matter Jurisdiction – Delaware Courts have personal jurisdiction in corporate disputes

• Service of process on corporate and alternative entity registered agents in Delaware• Director (and senior officer) subject to service of process under deemed consent statute• Contracting parties may consent to jurisdiction and service of process in Delaware

– Court of Chancery subject matter jurisdiction over corporate and contract disputes• Equity jurisdiction – jurisdiction over fiduciary duty disputes; equitable remedies• DGCL Section 111 – jurisdiction over claims involving charter, bylaws, voting agreements,

stock subscription agreements and merger agreements– 2016 amendment expanded jurisdiction to include (1) stock sale agreements to which the

corporation is a party and (2) asset sale agreements subject to stockholder approval• DRULPA Section 17-111 and DLLCA Section 18-111

Stockholders are Generally Free to Pursue Claims Outside Delaware

Forum Selection Bylaws Bind Non-party Stockholders to Delaware


Forum Selection Bylaws

– Delaware courts have enforced bylaws that require stockholders to litigate corporate claims in Delaware. Boilermakers Local 154 Retirement Fund v. Chevron.

– Court rationale is that bylaws operate as a contract among the corporation and its stockholders.

– Non-Delaware courts have generally enforced forum selection bylaws, including a California district court.


Sample clause:Unless the Corporation consents in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware (or, if and only if the Court of Chancery of the State of Delaware lacks subject matter jurisdiction, any state or federal court located within the State of Delaware) shall be the sole and exclusive forum for

(i) any derivative action or proceeding brought on behalf of the Corporation against one or more directors or officers of the Corporation alleging breaches of fiduciary duty or other wrongdoing by such directors or officers, (ii) any action or proceeding asserting a claim of breach of a fiduciary duty owed by any director or officer of the Corporation to the Corporation or the Corporation's stockholders, (iii) any action or proceeding asserting a claim against the Corporation or any director or officer of the Corporation arising pursuant to, or seeking to enforce any right, obligation, or remedy under, any provision of the DGCL, the Certificate of Incorporation, or these Bylaws (as each may be amended from time to time), (iv) any action or proceeding to interpret, apply, enforce, or determine the validity of any provision or provisions of the Certificate of Incorporation or the Bylaws (as each may be amended from time to time), or (v) any action or proceeding asserting a claim against the Corporation or any director or officer of the Corporation governed by the internal affairs doctrine,

in all cases to the full extent permitted by applicable law and subject to the court’s having personal jurisdiction over the indispensable parties named as defendants.


Stockholder Written Consents Developments 2017 Amendments to DGCL Section 228(c) – eliminated requirement that

stockholders date their signatures to written consents

– Prior to the Amendment, stockholder written consent was required to “bear the date of signature” of each signing stockholder, and the necessary number of consents was required to be delivered within 60 days of the date of the earliest dated consent delivered to the corporation.

– Amendment eliminates the requirement that stockholders date their signatures

• Written consents no longer need a date line next to each signature line, and may now follow the common “dated as of the first date above” format

– 60-day period for delivery of written consents now starts on the first day on which a consent is delivered to the corporation (not the earliest date of signature of the delivered consents)

– Amendment also eliminates the rule that the date of delivery of electronic consents is deemed to be the date it is signed

Stockholder Written Consents Developments Bylaws should be revised to conform to 2017 Amendment to

Section 228

– Regular updating of the statute can have its downsides – Bylaws often track statutory provision. When the statute changes such that the bylaw

and statute are no longer in agreement, questions may arise over which controls. Corporations may need to update bylaws to conform to statutory changes.

– Section 228 provides “unless otherwise provided in the certificate of incorporation”, but not the bylaws.

– Thus, bylaws cannot restrict stockholder right to act by written consent, but case law has upheld minimal restrictions designed to allow ministerial review of consents.

– Query whether a bylaw that requires consents “to bear the date of signature” would be valid as a “ministerial” requirement.

– In order to avoid doubt, conforming bylaw amendments may be appropriate

Ratification of Defective Corporate Acts DGCL Sections 204 and 205 (effective in 2014) permit Delaware

corporations to cure defective corporate actions through: – A specified ratification procedure (Section 204)– Court of Chancery procedure that provides the Court with jurisdiction to determine the

validity of any Section 204 ratification (Section 205)

Purpose and Effect:– Intended to address void/voidable issue– Overturns case law that prohibited ratification of void acts– Eliminates perceived disconnect with Delaware UCC– Confirms Chancery Court jurisdiction over ratification disputes– Non-exclusive; Common law ratification methods still exist– Will aid attorneys asked to render opinions with respect to capitalization and validity of

corporate actions

Ratification of Defective Corporate Acts Section 204 provides a safe harbor mechanism to validate a “defective

corporate act,” which is:– an act or transaction that is defective due to failure to authorize in compliance with the

DGCL, charter, bylaws, corporate agreement or plan– an “over issue,” or– defective election or appointment of directors

Ratification under Section 204 requires:– Board approval– Stockholder approval (if a vote would have been required on the matter at issue at the

time of prior act or at the time of ratification)– Notice must be given to all:

• current holders of voting and non-voting valid and “putative” stock, and• holders of voting and non-voting valid and putative stock as of the date of the

defective corporate act– File a certificate of validation with the DE Secretary of State if the matter being ratified

required the filing of a certificate.

Ratification of Defective Corporate Acts Section 205 confers jurisdiction on the Court of Chancery to hear and

determine:– validity of any ratification effected pursuant to Section 204– validity of any corporate act and any stock not ratified effectively pursuant to Section

204 (e.g., failure to receive stockholder vote)– validity of classic ratification not effected under Section 204

The legislative history of Sections 204 and 205 of the Delaware General Assembly notes that “[r]atification of a defective corporate act under Section 204 is designed to remedy the technical validity of the act or transaction; it is not intended to modify the fiduciary duties applicable to either the approval or effectuation of a defective corporate act or transaction or any ratification of such act or transaction. Defective corporate acts, even if ratified under this section, are subject to traditional fiduciary and equitable review.”

Since enactment, over 660 certificates of validation filed with the Delaware Secretary of State

Ratification of Defective Corporate Acts 204/205 Ratification provides significant flexibility to correct corporate

records– In re Trupanion, C.A. No. 9496 – VCP (Del. Ch. April 28, 2014) – Granted

corporation’s Section 205 petition to disregard prior defective reincorporation,validate prior issuances of stock, and determine the current board of directors.

– In re CertiSign Holding, Inc. (Del. Ch. Aug. 31, 2015) – Court validated ratification ofstock issuance made prior to effectiveness of amendment authorizing the issuedshares, refusing to consider a former director’s opposition based on the negativeimpact of the ratification on his rights as an option holder, noting that the statuteprohibits the Court from considering “any harm that would have resulted if thedefective corporate act had been valid when approved or effectuated.”

– Knoll Capital Mgmt. L.P. v. Advaxis, Inc. (Del. Ch. Jan. 29, 2016) – Court found thatstock sale by a corporation pursuant to an oral agreement, in violation of Delawarelaw, fell within Section 205, even if the board did not authorize the sale of stock, andthe fact that the board rejected the notion of a transaction a few days after it wasallegedly made did not mean that Section 205 was inappropriate.

Ratification of Defective Corporate Acts But 204/205 has its limits:

– Can’t be used to validate things that never happened: In re Numoda Corp.S’Holders Litig. (Del. Ch. Jan. 30, 2015) – Court declined to use its “substantialdiscretion” under Section 205 to authorize an act that was never taken or tobackdate an act that the corporation wants to have occurred earlier than it did.

– Can’t be used in place of traditional fiduciary or corporate control claims: Inre Genelux Corp. (Del. Ch. Oct. 22, 2015) (vacated in part on other grounds) – TheCourt denied corporation’s petition to invalidate share purported stock issuance toa founder, concluding that Section 205 was intended to cure otherwise incurabledefective acts, not to challenge stock issuances on grounds that were alreadyavailable (fiduciary duty claims, fraud claims, or Section 225 claims).

– Can’t be used to validate things that stockholders actually voted down:Nguyen v. View, 2017 WL 2439074 (Del. Ch. June 6, 2017) – The Court ofChancery denied defendants’ motion to dismiss, holding that, when corporate actsrequire stockholder authorization and a stockholder expressly declines to authorizethe act, the act is not subject to ratification under Section 204 of the DGCL.

Ratification of Defective Corporate Acts Nguyen v. View, 2017 WL 2439074 (Del. Ch. June 6, 2017)

– After 2007 Series A financing round:• Founder (former President) owned 70% of common (and thus controlled class vote of

common under DGCL 242(b)(2) to change the number, par value or rights of the common stock)

• VC investors held all of the Series A – 56% of fully diluted equity • Voting agreement – Founder entitled to one board seat; Series A designated board majority

– Disputes arise between Founder and View/Series A investors.– In 2009, Founder and View entered into a settlement agreement resolving the disputes, and

including Founder’s consent (as 70% common holder) in favor charter amendments to permit a Series B financing round.

– Settlement agreement was subject to seven-day revocation period. Founder revoked the settlement.

– Before Founder’s revocation, View closed the Series B financing. – Founder sued, and parties arbitrated claims regarding the revocation from 2010 through 2015.– While arbitration was pending, View closed additional financing rounds (Series C through F). – In December 2015, arbitrator ruled that Founder properly revoked the settlement agreement

including the consent to the Series B financing, thereby rendering the Series B financing invalid and void, resulted as a practical matter in the “collapse” of the company’s capital structure, which included subsequent Series C through Series F financing rounds

Ratification of Defective Corporate Acts Nguyen v. View, 2017 WL 2439074 (Del. Ch. June 6, 2017) (cont.)

– In 2016, View attempted to ratify the Series B financing pursuant to Section 204. Founder sued.– Court ruling:

• Denied View’s motion to dismiss Founder’s challenge to the ratification• Section 204 only permits ratification of corporate actions that are defective due to a “failure of

authorization” – e.g., failure to adhere to formalities, improper notice to stockholders, missing records, failure to properly seek board or stockholder approval. Ratification is not available to validate deliberately unauthorized acts. “Failure” is distinct from a “no” vote or outright rejection of the proposal by the majority of stockholders entitled to vote.

• Founder’s revocation of his consent was more than a mere failure of authorization as contemplated by Section 204. It was the classic exercise of the stockholder franchise to say “no” to a Board-endorsed proposal.

– Is withholding or revocation of written consent really the same as a vote against at a meeting?

• Court noted results “will be problematic if not potentially devastating for View.” • “View placed itself in this bind by aggressively pursuant multiple rounds of financing while the

outcome of the arbitration remained uncertain”.– What, if any, viable remedies are available to holders of the company’s Series C through

Series F preferred stock in light of the Court’s invalidation of the Series B Preferred?• Make-shift equitable remedy for View not available

Preferred Stock Issues:Limitations on Redemption Rights

Redemption is not a powerful contractual right for preferred stockholders– Preferred may have the downside of equity, without the upside of fully enforceable contract rights

Statutory limits– DGCL Section 160 Restrictions: Redemptions may not impair capital – i.e., may only be paid out of

“surplus” (or net assets less aggregate par value of outstanding shares)

Common law limits– Insolvency test – balance sheet and going concern test– Applies even if the terms “funds legally available” is not used in the redemption preference

Fiduciary duty limitations – Specific preferences of preferred stock are purely contract rights – preferences are not broadly

construed; Preferred is not entitled to more than its “bottom line rights”– Fiduciary duty of board runs primarily to the common, and not to preferred in connection with a

specific preference – board may be entitled (or obligated) to avoid redemption obligations• When a board faces a decision that would trigger a preference, and the interests of the

common and the preferred are not aligned, then the board’s action should be guided by its fiduciary duties to the common stock. Trados and QuadraMed

– Application of efficient breach theory


Frederick Hsu Living Trust v. ODN Holding Corp., 2017 WL 1437308 (Del. Ch. Apr. 14, 2017, corrected April 24, 2017) (“Oak Hill”)

– Oversee.com founded in 2000. Growth internally and by acquisitions over the years.– Oak Hill sole investor in Series A round in 2008 ($150 million).– Series A had a mandatory redemption put five years after investment, at $150 million (but no

cumulative dividends). If funds not legally available at time of redemption, charter required the company to take all reasonable actions (as determined by the Board in good faith and consistent with its fiduciary duties) to generate sufficient funds, by incurrence of debt, issuance of equity, selling assets, effecting a merger, or otherwise.

– In 2009, Oak Hill purchased common stock from a founder, giving it majority voting control. Three “Oak Hill” directors on the eight member board

– Starting in 2011, a “directional reset” – from growth to accumulating cash for redemption. • No additional acquisitions• Engaged in series of business line sales• Stockpiled cash• Management compensation bonus tied to redemption of at least $75 million

– Oak Hill demanded redemption in 2013– Special committee of the board oversaw series of divestitures and partial redemptions


Frederick Hsu Living Trust v. ODN Holding Corp., 2017 WL 1437308 (Del. Ch. Apr. 14, 2017, corrected April 24, 2017) (“Oak Hill”) (cont.)

– Court dismissed “funds legally available” challenge – The $150 million redemption obligation is not treated as a current liability under Delaware test, and company was not otherwise insolvent

– Court denied defendants’ motion to dismiss on the pleadings the fiduciary duty claims against the majority of the company’s directors, Oak Hill as controlling stockholder, and certain of the company’s officers.

– The Court found that plaintiff adequately pled that defendants breached their fiduciary duty of loyalty to the holders of the company’s “undifferentiated equity” (i.e., the common stockholders) by causing the company to change its business plan and engage in a series of transactions in order to maximize the amount of cash available to redeem the Oak Hill’s preferred stock, rather than maximizing the company’s long-term value for the holders of company common stock.• Board and committee acted as if Oak Hill was a secured creditor. • Oak Hill only possessed a right to require the Company to redeem the preferred stock to the

extent the company had surplus and legally available funds.• Board is subject to fiduciary duty of loyalty to the common (undifferentiated equity) when it

takes action to generate surplus and legally available funds.• Majority of board was conflicted in connection with actions related to redemption, thus subject

to entire fairness• Because Oak Hill was a controlling stockholder, the use of a special committee did not shift the

standard of review to business judgement


Frederick Hsu Living Trust v. ODN Holding Corp., 2017 WL 1437308 (Del. Ch. Apr. 14, 2017, corrected April 24, 2017) (“Oak Hill”) (cont.)

– Under the entire fairness standard, the complaint supported a reasonable inference that the Board unnecessarily diverted value to Oak Hill that otherwise would have accrued to the common

• The business line divestitures were at prices substantially below what the company had paid to acquire them

• Because the redemption price was fixed, delaying redemption would permit the company to pay in future dollars, the present value of which would diminish. Over a long-term horizon, the company conceivably could have grown its business, gradually redeemed all of the preferred stock, and then generated returns for its common stockholders

• Thus there is a reasonable inference that fiduciaries acting loyally would have continued to manage the company for the long term, rather than stockpiling cash so that Oak Hill could sweep it up


Ways to strengthen preferred stock redemption rights:– Use an LLC instead of a corporation

• Can shift fiduciary balance and modify governance – Provide for cumulative dividends

• Makes it harder for board to justify delay in payment in order to create long term return for common

• As noted in Oak Hill, “a cumulative dividend reduces the prospect that a corporation will generate value for the undifferentiated equity, because the company not only must continue as a going concern but also generate “a sufficient return to escape the gravitational pull of the large liquidation preference and cumulative dividends.”

– Penalty in event of failure to redeem• e.g., increase preference amount; ratchet up cumulative dividend rate

– Preferred stock consent rights on corporate capital expenditures and use of available cash

Preferred Stock Issues:Valuation in Appraisal

DGCL Section 262 – Right to petition the Court of Chancery for appraisal of the fair value of stock in a merger

Appraisal petitions have recently increased as a result of appraisal arbitrage, limits on effective fiduciary challenge to arm’s-length mergers

Hot issue in fair value determination involving public company merger deals is whether deal price is best evidence of fair value

– DFC Global Corp. v. Muirfield Value Partners LP (Del. 2017) – Reversing the Court of Chancery, the Supreme Court strongly endorsed reliance on deal price in arm’s-length transaction with a robust sales process, but no bright-line rule; Court rejected arguments that regulatory uncertainty undermines the reliability of the deal price and that a financial buyer’s pricing model undermines reliability of deal price

– Merion Capital L.P. v. Lender Processing Servs., Inc. (Del. Ch. 2016) – Court of Chancery determined that the fair value in appraisal proceeding was equal to the deal price under the circumstances, even in single bidder process, where preceded “meaningful competition” in the form of a pre-signing market check of heterogeneous potential bidders

– In re Appraisal of Dell Inc. (Del. Ch. 2016) – Court of Chancery determined that the fair value of Dell Inc. in an appraisal proceeding was 28% higher than the price paid for it by Michael Dell and Silver Lake Partners and approved by a majority of the unaffiliated shares after a lengthy and public arm’s-length sale process, holding that the deal price (which represented a ~30% premium to unaffected market) was not a reliable indicator of fair value under the circumstances, because the transaction was a management lead LBO, (ii) deal price determined by an LBO pricing model


Appraisal involving corporations with more than one stock class or series also have issue of allocation of “fair value” between classes or series

Delaware Chancery Court case law indicates that the fair value of convertible preferred stock is determined on an as converted to common basis, absent a “deemed liquidation provision” that is actually triggered by the merger or contract rights providing non-speculative elements of value.

– In re Appraisal of Metromedia Int’l Group, Inc., 971 A.2d 893 (Del.Ch. 2009) – Concluding that a convertible preferred stock’s anti-destruction clause (requiring that following a merger, the preferred stock would become convertible into whatever the common receives in the merger) mandated that the preferred be valued on an as converted to common basis.

– LC Capital Master Fund, Ltd. V. James (Del. Ch. Mar. 8, 2010) (“QuadraMed”) – Preferred stock entitled only to allocation of merger consideration based on conversion rights, and non-mandatory dividends do not justify allocation of additional value.

– Shiftan v. Morgan Joseph Holdings, Inc., 50 A.3d 928 (Del.Ch. 2012) – Fair value of preferred stock in a merger should reflect the mandatory redemption set to occur six months after the merger. Given the terms and timing, the redemption was non-speculative.

– In re Appraisal of The Orchard Enterprises, Inc. (Del.Ch. July 18, 2012) – In appraisal of common stock, primary issue was whether preferred stock would be valued in appraisal based on its deemed liquidation preference or on an as converted to common basis. Because the merger did not actually trigger the deemed liquidation preference (because the buyer was the preferred holder) the preferred stock was valued on an as converted to common basis.


In re Appraisal of Goodcents Holdings Inc., (Del.Ch. June 7, 2017). – Two common stockholders, including founder, owned 18% of voting power– Holders of cumulative convertible preferred stock owned 82% of voting power– Preferred liquidation preference – $73 million– In 2015, Goodcents acquired by AM Conservation Group for $53 million total consideration. All

consideration was paid to the preferred. The common received nothing.– The two common stockholders petitioned for appraisal. – Cross motion for summary judgment on the proper allocation of the fair value of the company

between the common and preferred stock – i.e., whether based on the preferred’s liquidation preference (in which case nothing would be left for the common) or on an as-converted to common basis (in which case the common would be entitled to roughly 18% of the fair value of the company).

– Court found that the charter provision at issue was not an effective “deemed liquidation” provision, but only a voting provision: “Without the affirmative vote of the holders of a majority of the preferred stock, the corporation shall not merger unless the consideration payable to stockholders is distributed pursuant to the liquidation preference.”

– Here, the preferred stockholders voted in favor of the merger. Therefore, the liquidation preference was not triggered.

– Court then found that the common stockholder were entitled to their proportionate share of the fair value of Goodcents considering the preferred stock on an as-converted basis.


Takeaways from preferred stock appraisal cases– In Goodcents and Orchard, the preferred stockholders were “overpaid” in the merger

compared to fair value of the preferred stock in appraisal.

– Buyers should make sure the deemed liquidation preference is actually triggered beforeagreeing to pay merger consideration to the preferred stockholders equal to theliquidation preference

– Amend the charter prior to merger in order to ensure the preferred have the contractualright to receive the contemplated merger consideration

– Buyers should ensure escrow and indemnity will cover appraisal awards to common

– NVCA form certificate of incorporation attempts to override In re Appraisal ofMetromedia Int’l Group, Inc. by adding to the anti-destruction provision a statement thatthe anti-destruction provision shall not be construed as preventing the preferredstockholder from seeking appraisal and shall not be deemed conclusive evidence of thefair value of the preferred stock in an appraisal proceeding.

Fiduciary Duty Case Law Developments

Fiduciary Duties under Delaware Law– Duty of care– Duty of loyalty (and good faith)

Standards of Review– Business Judgment Rule– Enhanced/Intermediate Scrutiny – Revlon and Unocal– Entire Fairness

Significant drop in merger litigation in Delaware– The end of disclosure-only settlements (Trulia)– Post-closing money damages cases subject to ratification dismissal under Corwin v.

KKR– Plaintiffs’ lawyers have gone elsewhere – Other states, Federal court (and forum

selection bylaws used in response to limit forum shopping)

Fiduciary Duty Case Law Developments Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304 (Del. 2015)

– Plaintiffs challenged stock-for-stock merger in which KKR & Co. L.P. acquired KKR Financial Holdings LLC at a 35% premium to the unaffected market price.

– The Court of Chancery dismissed the complaint, concluding, inter alia, that when a merger transaction is not subject to the entire fairness standard of review, the business judgment rule is invoked for a post-closing damages action if the merger is approved by a fully informed, uncoerced majority of the disinterested stockholders.

– On appeal, plaintiffs contended that the trial court should not have dismissed the complaint because they had adequately pled a claim under Revlon v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173 (Del. 1986). In response, defendants argued, among other things, that the transaction was subject to the business judgment rule because it had been approved by a fully informed, uncoerced vote of the disinterested stockholders.

– The Supreme Court held that, even if Revlon applied pre-closing, an arm’s-length transaction with a third party that is approved by an uncoerced, fully informed stockholder vote will invoke the business judgment rule.

– Decision treats the stockholder vote as a form of ratification that, absent a basis for alleging corporate waste, effectively serves to extinguish all process related claims.

Fiduciary Duty Case Law Developments Shareholder vote will extinguish loyalty claims against directors, but not

against controlling stockholders– Larkin v. Shah, 2016 WL 4485447 (Del. Ch. Aug. 26, 2016) – The Court explained that “when

disinterested, fully informed, uncoerced stockholders approve a transaction absent a looming conflicted controller, the irrebuttable business judgment rule applies.” According to the Court applying Corwin, “the only transactions that are subject to entire fairness that cannot be cleansed by proper stockholder approval are those involving a controlling stockholder.” That is, “proper stockholder approval of the transaction would cleanse any well-pled allegations that the transaction was the product of board-level conflicts that might trigger entire fairness review.”

Ratification applies to aiding and abetting claims– Singh v. Attenborough, 137 A.3d 151 (Del. 2016) – The Supreme Court affirmed the Chancery

Court’s finding that “a fully informed, uncoerced vote of the disinterested stockholders invoked the business judgment rule standard of review”, resulting in dismissal of, among other claims, aiding and abetting claims against the corporation’s financial advisor for failing to timely disclose potential conflicts of interests.

Ratification applies to tender offers in two-step transactions– In re Volcano Corp. S’holder Litig., 143 A.3d 727 (Del. Ch. 2016), aff’d (Del. Feb. 9, 2017) – The

Court found that the policy reasons underlying Corwin did not provide any basis to distinguish between a stockholder vote and a tender offer, and finding that a § 251(h) merger is not more coercive than single-step merger because the first-step tender offer must be for all of the target’s stock, the second-step merger must be effected as soon as possible, the consideration paid in second-step merger must be the same, and appraisal rights are available.

Fiduciary Duty Case Law Developments But dismissal is not guaranteed under Corwin

– 10/12/16 – In re OM Grp., Inc. S’holders Litig., 2016 WL 5929951 (Del. Ch.) (Court dismissed the plaintiffs’ post-closing claims under Corwin but characterized plaintiffs allegations that the target’s board of directors rushed to sell the company at a low price to avoid a proxy fight as a “disquieting narrative”)

– 4/11/17 – In re Saba Software, Inc. S’holders Litig., 2017 WL 1201108 (Del. Ch.) (Court concluding that the stockholder vote was neither fully informed nor uncoerced and so declined to dismiss under Corwin)

– 4/13/17 – In re Paramount Gold and Silver Corp. S’holders Litig., 2017 WL 57839 (Del. Ch.) (In a post-closing Unocal challenge premised on allegedly unreasonable deal protections, the Court acknowledged tension between Corwin and earlier decision of Supreme Court in Santa Fe that considered a Unocal challenge despite the approval of the transaction by a majority of the disinterested stockholders)

– 5/4/17 – In re Massey Energy Co. Deriv. and Class Litig., 2017 WL 1739201 (Del. Ch.) (rejecting defendants’ reliance on Corwin as basis to extinguish claims that existed pre-merger, Court notes that the “policy underlying Corwin, to my mind, was never intended to serve as a massive eraser, exonerating corporate fiduciaries for any and all of their actions or inactions preceding their decision to undertake a [merger]”)

– 5/31/17 – Sciabacucchi v. Liberty Broadband, C.A. No. 11418-VCG (Del. Ch.) (Court declined to dismiss under Corwin, finding reasonable inference that the company’s decision to condition two acquisitions on stockholder approval of two precedent financing transactions was structurally coercive)

Fiduciary Duty Case Law Developments Conflicted controlling stockholder transactions

– Implicate fiduciary duty of loyalty of the controlling stockholder and the controlled board of directors

– Entire fairness standard typically applies – requires fair price and fair dealing take

– Going private mergers and other self-dealing transactions involving a controlling stockholder typically subject to entire fairness

MFW provides roadmap to shift standard to business judgment rule in going private transactions

– From the outset, the controlling stockholder must condition the transaction on both of the following:

– Approval by a fully functioning and empowered special committee that is (i) comprised solely of disinterested and independent directors, (ii) empowered to freely select its own advisors and to say “no” definitively, and (iii) in compliance with its duty of care in negotiating a fair price; and

– Non-waivable approval by fully informed, uncoerced holders of a majority of the voting power of the outstanding shares held by the minority stockholders


Dismissal on the pleadings may be granted under MFW

– In re Books-A-Million, Inc. S’holders Litig. (Del. Ch. 2016)

– Court of Chancery dismissed, on the pleadings, plaintiffs’ post-closing claims for damages relating to a going-private transaction with controlling stockholder structured using the MFW framework

– Plaintiffs alleged that the merger provided a price per share that was below an alternative third party offer that the controller was not willing to support

– The court dismissed the claim holding that “[t]he plaintiffs’ complaint has not pled grounds to take the transaction outside of the [MFW] framework. The business judgment rule applies. The Merger cannot be viewed as an act of waste”


In re Books-A-Million (cont.)

– In the MFW context, claims will be dismissed at the pleading stage unless the facts pled support a reasonable inference that:

• an element of the MFW framework was not met;

• the transaction constituted “waste”; or

• the independent directors acted in “bad faith”

– The court also confirmed the following:

• a controller’s price is not grossly inadequate simply because it is below a third party offer; and

• a controller has a right to refuse to sell its shares or otherwise facilitate a third party offer


MFW doesn’t just apply to going private transactions

– In re Martha Stewart (Del. Ch. 2017)

– Controlling stockholder received same transaction consideration as other stockholders in third-party deal but purportedly received additional benefit related to certain employment agreements and IP-related contracts

– Court focused on timing

– MFW requirements were implemented after the merger negotiation process commenced, but prior to any negotiations with controlling stockholder

Blockchain Technology Developments “Blockchain” Defined

– “Distributed ledgers” recording ownership and transfer of assets on decentralized electronic networks.

– The term “distributed” signifies that each party on the blockchain network maintains a complete, accurate, and up-to-date copy of the same ledger.

– Blockchain technology enables the validation and recordation of transfers of assets between parties over peer-to-peer networks, and enables parties to transfer assets directly to one another without the costs and delays inherently resulting from the involvement of intermediaries.

– While such transfers typically require a trusted third-party intermediary to verify each transaction, blockchains instead rely on “proof” achieved by mathematical computation to determine if a transaction is authentic.

– Network participants collectively validate and record transfers on the blockchain through a computational process that requires real-time, secure, traceable, and authenticated transfers, and the blockchain is updated and replicated in real-time on each electronic database on the chain.

– Blockchains can be used to record ownership transfers of a variety of assets, including shares of stock.

Blockchain Technology Developments

Delaware Blockchain Initiative – Announced by Governor on May 2, 2017– Forefront of encouraging adoption of blockchain technology in private and public sectors

– Requested Council of Corporation Law Section of the Delaware State Bar Association to explore DGCL amendments to enable use of blockchain by corporations for registration and transfer of stock

Blockchain potentially provides solutions for some record keeping problems– Stock ledger maintained in centralized format on paper records or computer spread sheet

subject to inadvertent destruction or loss

– Records subject to input errors by individual in charge of records

– Costs associated with intermediaries such as transfer agents and nominee record holders

– Time delay between stock transfer and formal registration by corporate secretary or transfer agent

– Difficulty implementing transfer restrictions and tracing improperly transferred shares

– Publicly traded shares — Nominee/indirect holding system creates disconnect between record ownership and beneficial owners


August 1, 2017: Delaware corporate statute was amended to enable Delaware corporations to utilize blockchain technology to create and administer corporate records, including a corporation’s stock ledger

Amendments made to Section 224 (Form of Records), Section 219 (List of Stockholders Entitled to Vote), Section 232 (Notice by electronic transmission), Sections 151(f), 202(a) and 364 of the DGCL:

– Permit use of electronic networks or databases (including one or more distributed electronic networks or databases) as permissible forms for administering a stock ledger, so long as

• the records are convertible into clearly legible paper form;

• the corporation can prepare the list of stockholders specified in Sections 219 (stockholder meetings) and 220 (inspection of books and records) of the DGCL;

• it is capable of recording the information specified in Sections 156 (partly paid shares), 159 (collateral transfer), 217(a) (voting rights of fiduciaries, pledgors and joint owners of stock), and 218 (voting trusts and other voting agreements) of the DGCL; and

• it can record transfers of stock as governed by Article 8 of the Delaware UCC


Full implementation of blockchain in corporate context is a long way off

Corporations seeking to adopt blockchain technology should consider, among other things:

– Administration of the stock ledger (whether internal or through a third party service provider)

– Access to the distributed ledger

– Potential complications with respect to certificated shares

– Potential complications with respect to implementing transfer restrictions and other “rules”

– The interplay with the secondary securities market

California Law Update

Forms and Filings Filing Forms Have Been Updated

– Secretary of State has replaced several forms

• Statements of Information for CA and LLCs • Optional Statements of No Change (Form SI-500 NC) is now available

Electronic Signatures

– CA Secretary of State does not accept digital signatures (/s/, code or form of authentication is not technical signature) for business entity filings

– Electronic signatures (including docusign or PDFs) are acceptable for business entity filings made with the California Secretary of State, so long as the parties agree to the use of the electronic signature and can be filed electronically

Revised Uniform Limited Liability Company Act Effective January 1, 2014, RULLCA became the governing statute for

LLCs in CA Beverly-Killea Limited Liability Company Act, originally enacted in 1994, was repealed operative January 1, 2014

– There was no "opt-in" or "opt-out" procedure and there was no transition period.

– The RULLCA entirely replaced Beverly-Killea, with Beverly-Killea only applying tospecific matters involving pre-2014 LLCs, including:

• any action commenced, proceeding brought, or right accrued or accruingbefore 1/1/14 (CCC 17713.03)

• any vote or consent by managers or members of an LLC made prior to 1/1/14(CCC 17713.04(c))

• certain dissenter’s rights in LLCs formed prior to 2014 (CCC 17711.13(a))

In Kennedy v Kennedy (2015) 235 CA 4th 1474, after noting that the “statutory language” of RULLCA is ambiguous, court determined that Beverly-Killea governed withdrawal because the action was commenced before 1/1/14

Fiduciary Duties of Controlling Shareholders

There exists long-standing judicially created doctrine under which majority shareholders may not abuse controlling power to benefit themselves to detriment of minority shareholders

“Majority shareholders may not use their power to control corporate activities to benefit themselves alone or in a manner detrimental to the minority. Any use to which they put the corporation or their power to control the corporation must benefit all shareholders proportionately and must not conflict with the proper conduct of the corporation’s business.”Jones v Ahmanson & Co. (1969) 1 C3d 93

Ahmanson suggests significant exposure for one or more controlling shareholders in California (perhaps precluding a wide range of transactions including sales of control blocks at a premium)

Appears to be trend towards limiting Ahmanson


Kaul v. Mentor Graphics Corp, 2016 U.S. Dist. LEXIS 148464 (ND CA 2016)– Plaintiffs brought an action as minority shareholders of Calypto Design Systems, Inc.

("Calypto"), alleging Mentor Graphics Corporation ("Mentor") breached its fiduciary duty as majority shareholder.

– Court considered a host of substance law matters, including, Choice of Law, Internal Affairs, and Acceptance of the Benefits of the Transaction

– Choice of Law• Mentor contended that Delaware law governed dispute, as specified in the

choice-of-law provision in a Stockholders Agreement. • Plaintiffs argued that California law governed because Stock Purchase

Agreement attached as exhibit to the Agreement specified California law. • Court ruled that Stockholders Agreement, not Stock Purchase Agreement, was

pertinent to the fiduciary relationship. The Stockholders Agreement governed the existing relationship between Mentor and the other stockholders of Calypto, including voting of shares and elections to Board of Directors.


Kaul v. Mentor Graphics Corp, 2016 U.S. Dist. LEXIS 148464 (ND CA 2016)– Internal Affairs Doctrine

• Plaintiffs also argued that CA exception to "internal affairs doctrine" should be applicable because California has a more significant relationship to the parties and the corporation than Delaware.

• Court concluded that the internal affairs doctrine applies, as fiduciary duty claims and claims relating to internal corporate affairs should be governed by the law of state of incorporation (Calypto was DE corporation).

– Plaintiffs' Claim is Barred After Benefits of Transaction Have Been Accepted• In Bershad v. Curtiss-Wright Corp., 535 A.2d 840, 848 (Del. 1987) DE Supreme

Court ruled that when an informed minority shareholder either votes in favor of a merger or accepts the benefits of a transaction, cannot later attack fairness.

• Plaintiffs acknowledged they were informed minority shareholders. But they did not vote or acquiesce to transaction. Only relinquished shares due to contract.

• Court ruled breaches of fiduciary duty are barred when Plaintiffs accept benefits of transaction (including in cases of pre-negotiated call options), since consideration had been accepted.


Kaul v. Mentor Graphics Corp, 2016 U.S. Dist. LEXIS 148464 (ND CA 2016)– Fiduciary duties do not limit Mentor’s right to exercise its Call Option

• Plaintiff argued as a majority stockholder/fiduciary, Mentor had to pursue third-party sale or exercise its option when a potential third-party sale arose.

• Court concluded that whether parties performed in accordance with a pre-existing contract is key factor in determining whether there was a breach of fiduciary duty.

– Damages solely based upon breaches of fiduciary duty?• Plaintiffs argued Mentor breached its fiduciary duty when it exercised its call option,

causing harm of at least $0.16 per share. Additionally, Plaintiffs argued that courts may award damages solely based upon breaches of fiduciary duty.

• Court held that (i) Mentor’s “power and right to veto any third-party sale trumps its fiduciary duty to Calypto”; (ii) even if Mentor breached its fiduciary duty, damages stemming from the acquisition would not be proximately caused by breach of fiduciary duty but from its statutory right to veto. No cognizable damages.

“…where a dispute arises from obligations that are expressly addressed by contract, that dispute will be treated as a breach of contract claim…any fiduciary claims arising out of the same facts that underlie the contract…would be foreclosed as superfluous."

Inspection of Records California Corporations Code §§1600 and 1601 grants shareholders the

right to inspect shareholders ledgers and certain books and records and minutes of Board and shareholder proceedings

– Applies to all domestic corporations and foreign corporations that have their principal executive offices in California and foreign corporations that keep records in California.

If records are kept out of state, must corporation bring them to California for inspection?

– In Innes v. Diablo Controls, Inc. (2016) 248 Cal.App.4th 139, a California corporation kept its corporate records in its Illinois offices. The court held that the corporation's obligation was to make the records available for inspection at the office where the records were maintained (not exclusively at its principal business office), and did not include an obligation to transport records to California. The court noted that “maintaining the records in a remote location to intentionally impede inspection would be contrary to the purpose of section 1601.” Since “there is no evidence of such obstruction here,” the shareholders’ inspection rights had not been impeded.

Contract Drafting

Browsewrap “Terms of Use” Must Prominently Display Arbitration Clause– Because assent to Browsewrap Terms of Use must be inferred, a determination of

whether a binding browsewrap agreement has been formed depends on whether the user had actual or constructive knowledge of the website's terms and conditions

– Court noted (i) Plaintiff was never prompted to assent to the Terms of Use, (ii) he did not read them, and (iii) hyperlinks were too inconspicuous to impose constructive knowledge on Plaintiff, and (iv) hyperlinks and design of website would not have put a reasonably prudent Internet user on notice of arbitration clause

– Plaintiff therefore did not unambiguously assent to the subject arbitration provision simply by placing an order on ProFlowers.com

– In Long v Provide Commerce, Inc. (2016) 245 CA4th 855, the court found that there was no mutual assent to an arbitration provision in the seller's terms of use

Mr. Mullen’s practice focuses on corporate governance, mergersand acquisitions, and transactions involving Delaware businessentities. He regularly advises corporations, directors, boardcommittees and investors regarding fiduciary duties under Delawarelaw and all aspects of the Delaware General Corporation Law andDelaware partnership and LLC statutes. Tom is frequently engagedas counsel for conflict committees of master limited partnerships inconnection with drop downs, capital restructurings and M&Atransactions. He also provides legal opinions concerning Delawarebusiness entity statutes and corporate and commercial law issues.

He is the Chairman of the Jurisprudence Committee of the PrivateEquity & Venture Capital Committee of the American BarAssociation. He is also an active member of the Mergers &Acquisitions Committee of the American Bar Association’s Sectionof Business Law. He is a frequent speaker on Delaware corporateand alternative entity law, including continuing legal educationprograms and programs sponsored by the ABA and other barassociations.

Tom is recognized in Chambers USA: America's Leading Lawyersfor Business as a leading Delaware corporate/M&A and alternativeentities lawyer, and in The Best Lawyers in America in the area ofCorporate law.

He received a J.D. from the University of Pennsylvania Law in 1992and a B.A. from Franklin and Marshall College in 1989.

Thomas A. MullenPartner, Potter Anderson Corroon

Wilmington, DE

(302) 984-6204 T (direct)[email protected]

Speaker

Joshua Geffon is a strategic partner to entrepreneurs,executives and in-house legal teams, collaborating withinnovative companies throughout their life-cycles, fromnascent stage startups to billion dollar publiccorporations.

Joshua regularly advises emerging growth companies,conducts mergers and acquisitions for middle marketand public corporations, and provides counsel andadvice to boards of directors and senior managementon corporate governance, intellectual property andtechnology transactions. Joshua’s experience includesa significant number of purchase and salestransactions.

Joshua is the co-chair of the ABA Venture CapitalTransactions Subcommittee and is a member of theABA Mergers and Acquisitions and Legal OpinionsCommittees.

Joshua has been a Finalist for Corporate Counsel ofthe Year as identified by the Los Angeles BusinessJournal in 2015, and recognized as a Rising Star bySouthern California Super Lawyers in 2017, 2014, 2013and 2012.

Joshua D. GeffonShareholder, StradlingSanta Barbara, CA

(805) 730.6828 [email protected]

Speaker

800 Anacapa Street, Suite ASanta Barbara, CA 93101

sycr.com

The materials have been prepared for informational and educational purposes, do not create an attorney-client relationship with the author(s) or Stradling, and should not beused as a substitute for legal counseling in specific situations. These materials reflect only the personal views of the author(s) and are not necessarily the views of Stradlingor Potter Anderson Corroon or their respective clients.

All Rights reserved.

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Wilmington, DE 19801www.potteranderson.com

Delaware California Corporate Law Updates...• The company’s shares are not listed or traded on a national exchange – Potential impact of “quasi-California” status: • Stockholder

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