August.19.2019
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Corporate Governance Developments
Securities Law Developments
Two weeks ago, a Delaware Chancery Court dismissed a director oversight liability lawsuit alleging that JC Penny's directors had failed to implement systems to ensure compliance with pricing regulations after the Company settled a California class action alleging that the retailer used "false reference pricing" by routinely discounting "original prices" at which items had never been sold. In dismissing the case, the Chancery Court referenced JC Penny board minutes showing that directors had on multiple occasions discussed the class action and related regulatory compliance issues.
Contrast this decision with the Delaware Supreme Court's decision in June, in which it overturned the dismissal of an oversight lawsuit against the directors of ice cream manufacturer Blue Bell Creameries. That lawsuit alleged that Blue Bell's directors breached their duty of loyalty by having failed to oversee the Company's food safety operations after a listeria outbreak led to the deaths of three customers. The Court found it significant that the board minutes referenced in the complaint omitted any discussion by the directors of food safety or related compliance issues, the listeria outbreak, or the related deaths.
Link to decision.
Link to decision.
Practice Pointer: Boards must be able to show that they have made a good faith effort to discharge oversight responsibilities with respect to any key operational and compliance risks and challenges. Drafting sufficiently detailed board minutes showing that key risks and challenges were considered and addressed by directors can lead to an early dismissal of subsequent litigation.
A Delaware Chancery Court issued an important decision last week that held for the first time that a contractual waiver of appraisal rights imposed on common stockholders in a stockholder agreement in connection with a transaction that is not yet contemplated is valid and enforceable so long as the waiver language is clear and unambiguous. The reasoning of the opinion would appear to apply with equal force in favor of the enforceability of contractual waivers of Section 220 inspection rights — an issue which Delaware courts have not yet considered or decided in the affirmative.
Two weeks ago, the Delaware Supreme Court held that a tennis apparel company's records disclosed to an investor in connection with a Section 220 inspection demand were not subject to presumed confidentiality. The investor sued the company under Section 220 to gain access to the company's list of stockholders, board minutes, and financial statements. The lower court granted the request but imposed a confidentiality order of indefinite duration, reasoning that books and records produced to a stockholder under Section 220 are presumptively subject to a reasonable confidentiality order. The Delaware Supreme Court clarified that there is no presumption of confidentiality in Section 220 productions and it is the corporation's burden to demonstrate that confidentiality (and other restrictions) should apply.
Practice Pointer: The Delaware Supreme Court's clarification that there is no presumption of confidentiality is in the context of a Section 220 demand that is denied by the corporation and then litigated in court. Companies can still insist on strong confidentiality agreements as a condition to inspection prior to litigation. If your client receives a Section 220 books and records demand, involve your securities litigators who can negotiate with the stockholder's counsel to avoid litigation over the demand and still ensure the company's records are adequately protected from improper use or disclosure.
Plaintiffs filed securities class action lawsuits at "near-record levels" during the first six months of 2019, according to a new report — figures which contrast with the number of publicly traded companies, which has declined in recent years. By year's end, 396 securities class action filings are expected, which represents an 87 percent increase over the 1997-2018 annual average of 212, but a slight decrease from the 403 year-end total for 2018. This means general counsel today are looking at a more than 5% chance that their company will be sued this year due to a drop in stock price.
Takeaway: Stock-drop cases are on the rise — any material stock price drop has a significant likelihood of generating securities litigation. Consult with your securities litigators to review client earnings releases or other disclosures that might cause a negative market reaction.
A New York County Supreme Court held two weeks ago that "[t]here simply is no basis to find that Congress intended for [the automatic stay provision of the Private Securities Litigation Reform Act of 1995] to only apply to actions brought in federal court." The Court reasoned that Congress had passed the PSLRA to curtail frivolous securities lawsuits hoping to achieve early settlement — and that Congress's reasoning applied equally in state court.
Last month, the Third Circuit dismissed Tibet Pharmaceuticals Inc. investors' last remaining claim against two board observers, an investment banker and an early investor who had worked on Tibet's initial public offering, allegedly liable for misrepresentations about a company's financial well-being ahead of its public debut, finding that board observers, who do not have voting rights, are distinct from directors. The claim arose under Section 11 of the Securities Act of 1933, which is limited to any defendant "named in the registration statement as being or about to become a director, person performing similar functions, or partner." Unlike the district court, the Third Circuit determined the pair's responsibilities as board observers didn't qualify them as people "performing similar functions" to a director.
Takeaway: The decision offers welcome clarity for a broad class of board observers — and private equity and venture capital funds and other third parties who often designate people to serve in such positions — as it supports the customary industry view that observers do not carry the fiduciary duties and concomitant exposure to liability that are ascribed to actual board members.