A recent decision by the Massachusetts Appeals Court interprets the right of a seller shareholder to bypass a stockholders’ representative and settle directly with a buyer claimant and to use for such settlement the proceeds from an escrow fund established as part of the sale transaction.  This opinion is an important read for anyone engaged as a stockholders representative or serves as counsel to one.   While the decision is somewhat limited by the specific provisions of the merger and escrow agreements at issue, corporate practitioners may find the facts useful for tightening up standard provisions on these issues in future deals.  The case also provides a handy explanation of the oft-used (and misunderstood) term “power coupled with an interest”, which we have summarized below.  A full copy of the opinion can be found here.

The case arises from a stock purchase merger in September 2007 of Atlantis Components, Inc. by Astra Tech, Inc.  for $71 million. Per common practice, $6.3 million of the purchase price was placed into an escrow fund, to be disbursed to the former Atlantis shareholders on a pro rata basis on December 31, 2008, the release date. The purpose of the the escrow fund was to indemnify Astra Tech if it paid any claims asserted against Atlantis after the closing date but before the release date. The merger agreement designated a Shareholder Representative as the agent of the former Atlantis shareholders, which had the duty of approving or challenging any indemnification claim on the escrow fund.

Shortly after the closing, Astra Tech brought a claim against Atlantis for failing to disclose  certain correspondence alleging that Atlantis was infringing on the patents of one its competitors.   The parties disagreed on the merits of AstraTech’s claims and various lawsuits ensued.  As legal costs for these matters ballooned to nearly $2.5 million, in October 2010 certain of the Atlantis shareholders opted to settle directly with Astra Tech, using their pro rata share of the escrow fund as payment.  After reaching an agreement, the settling shareholders and Astra Tech moved in Superior Court for approval of their settlement. The shareholders’ agent opposed the settlement, on the basis that neither the merger agreement nor the escrow agreement permitted the settling shareholders to seek disbursement absent the consent of the shareholders’ agent. A judge approved the settlement agreement between Astra Tech and the settling shareholders and this appeal followed.

The Court’s decision involved the interpretation  and interplay of three contracts between the parties: (1) the escrow agreement between Astra Tech, Atlantis, the stockholders rep, and the escrow agent; (2) the merger agreement between Astra Tech, Atlantis, and the stockholders rep; and (3) the settlement agreement between Astra Tech and the settling shareholders.

On the escrow agreement, the Court determined that that the express provisions of that Agreement did provide for a procedural mechanism to allow the settling shareholders to seek court approval of their settlement.  An excerpt of that provision is provided below for reference. (1)

On the merger agreement, the stockholders rep argued that it had the exclusive right to negotiate with Astra Tech under under Sections 8.6(a) and (e) (pasted as footnote (2) below).  While the Court agreed that these provisions granted the Stockholders Rep with broad powers to negotiate and make decisions for the settling shareholders, it held that these rights were not exclusive, which would be required to bar the settling shareholders from negotiating for themselves.  The Court refused to construe the provision that the rep’s decisions and acts “constitute a decision of all Company shareholders” and are “final, binding and conclusive upon each such Company Shareholder” as granting the rep with exclusive rights.   To create an exclusive agency, the parties must expressly and unambiguously indicate such an intent in the contract.”  The Court noted that if the parties had wished to give the shareholders’ agent the sole or exclusive authority to negotiate on behalf of the settling shareholders, they should have provided for that expressly in the contract. (“We will not contort the plain language of the merger agreement to interpret “final, binding and conclusive” as synonymous with “irrevocable” or “exclusive.”)

Finally, the stockholders rep contended that its agency was irrevocable because it has a “power coupled with an interest.”  The Court disagreed.   Despite general agency law principles (which allow a creator of the agency relationship to revoke the agent’s authority at any time, even if their agreement expressly states that the principal may not revoke), the agent’s authority can be made irrevocable when it is a “power coupled with an interest”.  The Court explained that a ”power coupled with an interest is not technically an agency relationship because “it is neither given for, nor exercised for, the benefit of the person who creates it.”  In an agency relationship, granting authority to the agent is solely for the benefit of the principal, but when a “power is coupled with an interest, the donee holds that power for his own benefit (or for the benefit of a third party), but not for the benefit of the donor.”  The reference to “interest” in this phrase means that the agent (donee of the power) must have a present interest in the property upon which the power is to operate.  It is generally accepted that the “interest” must be ownership of the property itself and it is this ownership which makes the power irrevocable.

In its analysis, the Court broke down the term “a power coupled with an interest”  into two components: first, does the agent have “a power”, and second, is the power “coupled with an interest.  On the first point, the Court held that the  rep did not have “a power” in the escrow fund, as it did not have  exclusive or irrevocable power under the merger agreement or the escrow agreement.  The rep also did not have unilateral power in the escrow fund (a distinguishing factor in other cases cited by the Court) but rather was required to reach an agreement with Astra Tech before the escrow agent could be compelled to release the funds.

On the second point, the stockholders rep did not have “an interest” in the escrow fund sufficient to create a power coupled with an interest.  Citing cases going back to 1823, the common thread requires the agent to have title or some other form of ownership of the underlying asset to assert that the power is “coupled with an interest”.   Even though the shareholders rep (as a Atlantis shareholder) had a personal interest in a portion of the escrow, it did not have a property interest in the entire fund in its capacity as shareholders’ agent.  The Court emphasized that the critical distinction between an agent and the donee of a power coupled with an interest lies in who receives the benefit of the relationship. “In a principal-agent relationship, the principal receives the benefit; for a power coupled with an interest, the benefit inures to the donee himself (or to a third party), but not to the donor.”

After concluding that the stockholders rep had neither the exclusive right to negotiate under the merger agreement nor a power coupled with an interest in the entire escrow fund, it then held that the settling shareholders did have a right to bypass the rep and enter into a direct settlement with Astra Tech.  In the absence of an agreement, the settling shareholders retain their common-law rights as principals. Notwithstanding any agreement between principal and agent, an agent’s actual authority terminates … if the principal revokes the agent’s actual authority by a manifestation to the agent. Because a principal may revoke part of the agent’s authority, it follows that a principal may, in the absence of an agreement to the contrary, negotiate on his own behalf without infringing on the agent’s ability to perform his duties.  Because nothing in the agreements abrogated these common-law rights, the Court held that the settling shareholders had the power to negotiate a settlement agreement with Astra Tech.

This opinion illustrates a number of interesting drafting points for preparing escrow and stockholder rep provisions in complex merger and sale agreements.  At the very least, practitioner may wish to counsel their clients on the alternatives of exclusive and nonexclusive roles of the rep and the possible ways those results can be effected.  Based on this decision, it appears likely that a Massachusetts court facing a similar issue will construe these agreements strictly and will require the exclusivity and revocability to be expressly stated to be enforceable.

If you have any questions regarding the issues discussed in this point, please feel free to contact us.

Footnotes:

(1) ”Any Disputed Claim and any other dispute which may arise under this Escrow Agreement with respect to the rights of [Astra Tech] or any other Indemnified Party and the Shareholders’ Agent or the Company Securityholders to the Escrow Fund shall be settled by mutual agreement of [Astra Tech] and the Shareholders’ Agent (evidenced by joint written instructions signed by [Astra Tech] and the Shareholders’ Agent and delivered to the Escrow Agent); provided, however, that upon receipt of a copy of a final and nonappealable order of a court of competent jurisdiction with respect to payment of all or any portion of the Escrow Fund, … the Escrow Agent shall deliver the portion of the Escrow Fund specified in such award or order to [Astra Tech] or other Indemnified Party and/or the Shareholders’ Agent for the benefit of the Company Securityholders as directed in such award or order.”

(2)  ”[T]he Shareholders’ Agent shall be, and hereby is, appointed and constituted in respect of each Company Securityholder, as his, her or its agent, to act in his, her or its name, place and stead, as such Company Securityholder’s attorney-in-fact, as more fully set forth in this Section 8.6. Without limiting the generality of the foregoing, the Shareholders’ Agent shall be constituted and appointed as agent for and on behalf of the Company shareholders to give and receive notices and communications, to authorize delivery to [Astra Tech] of the monies from the Escrow Fund in satisfaction of claims by [Astra Tech] Indemnified Persons against the Escrow Fund, to object to such deliveries, to agree to, negotiate, enter into settlements and compromises of, and demand arbitration and comply with orders of courts and awards of arbitrators with respect to such claims, and to take all actions necessary or appropriate in the judgment of the Shareholders’ Agent for the accomplishment of the foregoing.” [FN13]

Section 8.6(e) further delineates the actions that may be taken by the shareholders’ agent:

“A decision, act, consent or instruction of the Shareholders’ Agent shall constitute a decision of all Company shareholders … and shall be final, binding and conclusive upon each such Company shareholder, and the Escrow Agent and [Astra Tech] may rely upon any decision, act, consent or instruction of the Shareholders’ Agent as being the decision, act, consent or instruction of each and every such Company shareholder.”

Tags: acquisition, astra tech, atlantis, change of ownership, change of stock, change of stock ownership, corporate law, coupled with an interest, escrow agent, escrow agreement, escrow fund, indemnification, massachusetts appeals court, Massachusetts law, massachusetts supreme judicial court, merger, post closing liability, power coupled with an interest, reverse triangular merger, shareholder rep, shareholder representative, shareholdersrep, stock acquisition, stockholder agent, stockholder rep, stockholder representative, stockholdersrep

A recent Massachusetts Appeals Court decision impacts businesses that deal with out of state companies, an issue that is much more common today thanks to the advent of e-commerce. Diamond Group, Inc. v. Selective Distribution International, Inc. expands personal jurisdiction and allows a Massachusetts business lawsuit to move forward against a Long Island company. The finding is based on the orders placed over emails between the two businesses.

Diamond, a Massachusetts company, sued Selective Distribution in a Massachusetts court for 45 unpaid invoices. Selective Distribution, a Long Island business, filed a motion to dismiss based on a lack of personal jurisdiction. The argument Selective made was the standard “minimum contacts” argument from the 1945 International Shoe case: the business had no presence in Massachusetts, and all deliveries it received came to its warehouses in New York and New Jersey.

The Court examined the International Shoe criteria and based its decision within them, albeit expanding them. First, the Court found that the series of email orders itself constitutes “purposeful availment” of Massachusetts commercial activity. Distinguishing this case from others in which personal jurisdiction was found absent based on the International Shoe standards, the Court explained that this ongoing pattern was far different than cases where single purchases or isolated transactions were involved. In contrast, Selective was a regular and active participant in Massachusetts commercial circles and this deliberate and routine involvement signaled that “traditional notions of fair play and substantial justice” would not be offended by the assertion of personal jurisdiction over the business.

Whether or not the Massachusetts Supreme Judicial Court will accept further appellate review is up in the air. For now, the clear take away is that doing business online with out of state companies can open your business up to liability in other states if this expanded understanding of personal jurisdiction holds up. This case is an important reminder of the benefits of including a governing law and dispute resolution clause in your contract forms to provide for a favorable locale as the exclusive forum for any proceedings to take place.

If you have any questions about this topic, please feel free to email us.

Tags: choice of law, commercial activity, contract, contract forms, corporate law, Diamond Group, dispute resolution, dispute resolution clause, e-commerce, forum selection, Inc., Inc. v. Selective Distribution International, international shoe, massachusetts appeals court, Massachusetts law, massachusetts supreme judicial court, minimum contacts, motion to dismiss, personal jurisdiction, purposeful availment, Selective Distribution, traditional notions of fair play, traditional notions of fair play and substantial justice

A recent Delaware Supreme Court decision in SIGA Technologies v. PharmAthene reaffirmed established Delaware law that an express promise to negotiate an agreement in good faith may be enforceable.   The Court also held that expectation damages may be awarded under Delaware law if a trial court can conclude that the parties would have reached an agreement but for a defendant’s bad faith.  Since term sheets are such a key part of the venture capital and M&A process, the SIGA decision illustrates the importance of carefully thinking through the details (or lack thereof) of a term sheet and their specific wording.  In particular, if at the time of a term sheet the parties are unsure of their intent, or wish to leave the negotiations open, to avoid potential damages awards appropriate disclaimers to any duty to negotiate in good faith should be included.

Of important note, in light of the SIGA decision, the Term Sheet for the NVCA Model Legal Documents has been updated to point out that the choice of law governing the term sheet should be considered more carefully.  (See footnote 1 (pasted below) to NVCA Term Sheet, found here).

If you have any questions about this topic, please feel free to email us.

Background

The SIGA decision arose in the context of negotiations between SIGA and PharmAthene (PA) relating to a potential collaboration.  At the outside of the process, SIGA was in a troubled financial state and was interested in licensing to PA rights to SIGA’s drug relating to smallpox.  While PA expressed interest in a merger, SIGA was not ready to commit to a merger process at that time.  The parties spent a number of months negotiating a detailed term sheet for a license agreement (“LATS”) which provided for a material terms, including those describing the worldwide exclusive license and sublicensing rights, various forms of upfront and milestone cash payments, funding guarantees and governance procedures. The LATS was not signed and had a footer that stated “Non Binding Terms.”

To add complexity to the matter, following the LATS, as the parties continued to negotiate, they entered into additional agreements.  PA provided SIGA with a $3 million bridge loan to provide SIGA with working capital while the merger negotiations proceeded.  The bridge loan agreement (governed by New York law) contained a provision obligating the parties to negotiate in good faith a license agreement “in accordance with the terms” set forth in the LATS if the merger were terminated.  Thereafter, SIGA and PA also into a Merger Agreement (governed by Delaware law) that contained the same provision as in the LATS requiring the parties to negotiate a license agreement in good faith in accordance with the terms LATS if the Merger Agreement were terminated.

After signing the Merger Agreement, SIGA’s financial position and prospects improved and it ultimately terminated the Merger Agreement.  While the parties then proceeded to negotiate the terms of the definitive license agreement, SIGA responded to a PA’s draft by proposing significant changes from the deal contemplated by the LATS.  The changes included a different profit splits, increased upfront payments ($100 million instead of $6 million, as specified in the LATS), and increased milestone payments ($235 million instead of $10 million, as specified in the LATS).  After SIGA conditioned any further discussions on PA’s agreement to negotiate without any preconditions regarding the binding nature of the LATS,  PA sued in the Delaware Chancery Court, asserting claims under theories of breach of contract, promissory estoppel and unjust enrichment.  After the Chancery court held in favor of PA on various grounds, SIGA appeal.

Legal Analysis

The Delaware Supreme Court held that that an express contractual obligation to negotiate in good faith is enforceable under Delaware law.  The Court affirmed the Chancery Court’s determination that SIGA acted in bad faith when it negotiated the license agreement in breach of its obligations under the Merger Agreement and the Bridge Loan Agreement.  The Court recited the standard for bad faith under Delaware law “is not simply bad judgment or negligence, but rather … the conscious doing of a wrong because of dishonest purpose or moral obliquity; it is different from the negative idea of negligence in that it contemplates a state of mind affirmatively operating with furtive design or ill will.”

Looking to precedent from both Delaware and New York, the Court reasoned that parties that bind themselves to a concededly incomplete agreement “accept a mutual commitment to negotiate together in good faith in an effort to reach final agreement within the scope that has been settled in the preliminary agreement.”  While good faith differences in the negotiation of open issues may prevent reaching a final contract, a counterparty cannot in that case insist on conditions that do not conform to the preliminary agreement.

On that basis, the Court interpreted the language “in accordance with the terms set forth [in the LATS]” to mean that the parties had a duty to “negotiate toward a license agreement with economic terms substantially similar to the terms of the LATS (or at least not inconsistent with the LATS’s terms),” as opposed to using the LATS only a “jumping off point.”  Although the LATS was not signed and had the “Non-binding” footer language, the fact that it was incorporated into the Bridge Loan Agreement and Merger was evidence of intent to negotiate toward a license agreement with substantially similar economic terms in the event the merger was not closed.

This decision also establishes that under Delaware law, contract expectation damages are an appropriate remedy where parties have preliminarily agreed to the major terms of an agreement (a Type II agreement, as discussed) and have agreed to negotiate its conclusion in good faith, and the record supports that they would have reached agreement but for bad faith.

To reach its holding, the Court looked to decisions under New York law interpreting preliminary agreements, which provide for two types of such agreements: a “Type I” agreement and a “Type II” agreement.

• A Type I agreement “is a fully binding preliminary agreement, which is created when the parties agree on all the points that require negotiation (including whether to be bound) but agree to memorialize their agreement in a more formal document. Such an agreement is fully binding….”
• A Type II agreement is where parties “agree on certain major terms, but leave other terms open for further negotiation. … — a concededly incomplete agreement accept[ing] a mutual commitment to negotiate together in good faith in an effort to reach final agreement within the scope that has been settled in the preliminary agreement.”
  • A Type II agreement “does not commit the parties to their ultimate contractual objective but rather to the obligation to negotiate the open issues in good faith in an attempt to reach the alternate objective within the agreed framework.” A Type II agreement “does not guarantee” the parties will reach agreement on a final contract because of “good faith differences in the negotiation of the open issues” may preclude final agreement. A Type II agreement “does, however, bar a party from renouncing the deal, abandoning the negotiations, or insisting on conditions that do not conform to the preliminary agreement.”
    

1.  NVCA Term Sheet FN. 1.  ”The choice of law governing a term sheet can be important because in some jurisdictions a term sheet that expressly states that it is nonbinding may nonetheless create an enforceable obligation to negotiate the terms set forth in the term sheet in good faith.  Compare SIGA Techs., Inc. v. PharmAthene, Inc., Case No. C.A. 2627 ( (Del. Supreme Court May 24, 2013) (holding that where parties agreed to negotiate in good faith in accordance with a term sheet, that obligation was enforceable notwithstanding the fact that the term sheet itself was not signed and contained a footer on each page stating “Non Binding Terms”);  EQT Infrastructure Ltd. v. Smith, 861 F. Supp. 2d 220 (S.D.N.Y. 2012); Stanford Hotels Corp. v. Potomac Creek Assocs., L.P., 18 A.3d 725 (D.C. App. 2011) with Rosenfield v. United States Trust Co., 5 N.E. 323, 326 (Mass. 1935) (“An agreement to reach an agreement is a contradiction in terms and imposes no obligation on the parties thereo.”); Martin v. Martin, 326 S.W.3d 741 (Tex. App. 2010); Va. Power Energy Mktg. v. EQT Energy, LLC, 2012 WL 2905110 (E.D. Va. July 16, 2012).  As such, because a “nonbinding” term sheet governed by the law of a jurisdiction such as Delaware, New York or the District of Columbia may in fact create an enforceable obligation to negotiate in good faith to come to agreement on the terms set forth in the term sheet, parties should give consideration to the choice of law selected to govern the term sheet.”

Tags: bad faith, expectation damages, good faith, NVCA, NVCA Model Legal Documents, NVCA model series A term sheet, preliminary agreement, promissory estoppel, Series A, Series A term sheet, term sheet

In September 2013, California signed into effect three new laws relating to privacy and data breach. The first is online privacy bill A.B. 370 which amends the California Online Protection Act to add privacy policy disclosure requirements regarding online tracking activity by website operators.  This amendment goes into effect on January 1, 2014.

Under current California law, operators of commercial websites or online services (including mobile applications) that collect personally identifiable information (commonly referred to as “PII”) through the Internet about consumers residing in California who use or visit their commercial website or online service to conspicuously post a privacy policy on its website or online service and to comply with that policy.  The privacy policy is required to disclose the categories of PII that are collected and the categories of entities with whom such information is shared.

The 2013 law requires an operator that collects PII concerning a consumer’s online activities now also to disclose (1) how it responds to Web browser ‘do not track’ signals or other mechanisms that provide consumers the ability to exercise choice regarding the collection of a PII, and (2) whether third parties may also collect PII about an individual consumer’s online activities over time and across different websites when a consumer uses the operator’s website or service.

To be compliant with the new law, a privacy policy must not meet all of the following requirements:

The second new law is S.B. 46, which adds to the current data security breach notification requirements a new category of data triggering these notification requirements: A user name or email address, in combination with a password or security question and answer that would permit access to an online account. The new law also provides more guidance on how website operators can satisfy disclosure obligations when a breach involves personal information that allows access to an online or email account.  This law also goes into effect on January 1, 2014.

Finally, S.B. 568, relates to online privacy protection for minors. This law will prohibit online marketing or advertising of certain products and services (such as alcohol, tobacco, and U/V tanning products) to children and teenagers under 18.  This law goes into effect on January 1, 2015.

Impacted companies must take the opportunity presented before these laws come into effect to examine their data collection, data privacy, and security policies and practices to determine whether they demand any updates. If you have any questions about this topic, please feel free to email us.

Tags: California Online Protection Act, data security, do not track, Online privacy bill A.B. 370, personally identifiable information, PII, privacy policy, S.B. 46, S.B. 568, startup, terms and conditions, terms of service

In September the SEC issued two new alerts via its Office of Investor Education and Advocacy for investors. These alerts concerned the SEC’s new general solicitation rules and the details on the new definition of “accredited investor.” These alerts are available here on the SEC’s website at the following links:

New General Solicitation Rules

Accredited Investor Definitions

The alert concerning the general solicitation rules reminds investors of the variety of risks inherent to private placements. For example, there are differences between the relevant offering documents of private placements and registered offerings; private placement documents do not generally present the investor with as much information concerning the issuer and the offering. Furthermore, the failure of an issuer to verify accredited investor status might well be a red flag about the overall health of the offering.

In tandem with this, the SEC’s “accredited investor” alert is designed to assist investors in knowing whether they are accredited investors. It details several examples of the “net worth” test in practice using factual examples.

The alerts are the latest of the SEC’s ongoing attempts to curb inappropriate use of the general solicitation rules, and to ensure that the risks of investments are clear to private placement investors.

If you have any questions about this topic, please feel free to email us.

Tags: accredited investor, general solicitation rules, investors, issuer, Office of Investor Education and Advocacy, private placements, registered offerings, SEC

Private equity and venture capital funds who distinguish themselves as being “active investors” should take note of a recent First Circuit decision in the Sun Capital Partners III et al v. New England Teamsters & Trucking Industry Pension Fund decision where the could The First Circuit found a private equity fund can be jointly and severally liable for the unfunded pension obligations of companies in its portfolio where it took an active role in the company’s business.

The portfolio company in question, Scott Brass, Inc., went into bankruptcy and defaulted on its withdrawal obligations to the New England Teamsters &Trucking Industry Pension Fund (Teamsters) at a time when the company was held by two Sun Capital Funds. The Teamsters argued that the funds were jointly and severally liable for the Scott Brass obligations because they were engaged in a trade or business and were controlled by ERISA along with Scott Brass.

The Massachusetts federal district court disagreed in late 2012 and held that the Sun Capital funds were not trades or businesses, and were instead private investment funds whose only function was to receive investment income. The First Circuit, in a decision that was admittedly “fact specific”, reversed, reasoning that what might otherwise be a passive investment could qualify an investor to be a trade or business when it is coupled with certain activities. The court referred to this as the “investment plus” analysis but declined to establish specific guidelines for what those “certain activities” might be.

Factors that the court did mention include:

• The general partners of the Sun Capital funds had hiring and firing authority and otherwise managed the day-to-day operations of their portfolio companies.
• Sun Capital affiliates actively worked on improving and restructuring the portfolio in order to sell it at a better price. These affiliates also served on the boards of portfolio companies and held the majority of the seats on the Scott Brass board.
• Sun Capital Fund IV in particular received management fees from Scott Brass.

These factors prompted the Court to render its decision as to Sun Capital Fund IV and to remand the case as to Sun Capital Fund III for a new “trade or business” analysis; the receipt of management fees from Scott Brass is a key consideration.

Even if ERISA work isn’t your area, this case is an important reminder that even well-crafted reps and warranties and corporate limited liability shields may not protect an investor from being pursued by creditors of a portfolio company, especially a bankrupt one. For legal issues such as funded and unfunded retirement plans covered by ERISA, there is no substitute for careful due diligence by specialized professionals. Second, investors who find themselves in a similar situation should seek guidance from the Sun Capital case on how to manage the investment without toeing the line that results in potential exposure to the fund managers and their assets.

If you have any questions about this topic, please feel free to email us.

Tags: "investment plus" analysis, due diligence, ERISA, first circuit, funded and unfunded retirement plans, joint and several liability, Massachusetts federal district court, new england teamsters, pension fund, portfolio, private equity, sun capital, trade or business, venture capital

A recent letter opinion by the Delaware Chancery Court in a case between Shareholder Representative Services (SRS) and a buyer of a business processing business raises an interesting interpretation of an arbitration clause in a merger agreement. The case can be read here.  The dispute between the parties arose from indemnification claims brought by the buyer under the merger agreement, which SRS claimed did not comply with the requirements of the merger agreement.  While the merger agreement contained a mandatory arbitration provision, it also provided that the Arbitrator did not have authority to grant “injunctive relief, specific performance or other equitable relief”.  Relying on this provision, SRS brought various claims in the Chancery Court, including a claim for injunctive relief to stop buyer from a breach of the merger agreement by seeking indemnification to which it did not have a right.  The court disagreed with SRS and compelled arbitration.

The court first noted that since the arbitration clause did not explicitly commit the determination of substantive arbitrability to the arbitrator, the court had jurisdiction to decide on this specific issue.  In a footnote, the court noted that these issues are presumptively determined by a court.  (One drafting note from this determination is that parties that wish to avoid any court proceedings altogether may want expressly cover the issue of substantive arbitrability in their agreement.)

The court cited a 2002 Delaware Supreme Court decision for the steps to be taken by a Delaware court to assess an arbitration clause:

• First, the court must determine whether the arbitration clause is broad or narrow in scope.
• Second, the court must apply the relevant scope of the provision to the asserted legal claim to determine whether the claim falls within the scope of the contractual provisions that require arbitration. If the court is evaluating a narrow arbitration clause, it will ask if the cause of action pursued in court directly relates to a right in the contract. If the arbitration clause is broad in scope, the court will defer to arbitration on any issues that touch on contract rights or  contract performance.

The court cited a few examples of a “broad” arbitration clause:  “any dispute, controversy, or claim arising out of or in connection with the …Agreement” and “any unresolved controversy or claim arising out of or relating to this Agreement” (the language at issue in the parties’ merger agreement). Finding this clause to be of the broad category, the court ruled that the determination of whether the indemnification claims were time-barred should be made by the arbitrator.

In support of its argument, SRS cited a 2006 decision involving an arbitration clause in a LLC operating agreement where the parties also sought injunctive relief from the court to compel a member to assent to a capital contribution.  The court distinguished this situation from the instance case, finding that SRS’s claims were really legal claims, not equitable ones, and colorfully noted that “[s]emantic legerdemain does not transform a legal claim into an equitable claim.”  The court reasoned that the relief that SRS has requested requires an analysis of the merits of the claims, which is legal (as opposed to equitable) in nature.   Accordingly, a plaintiff cannot “convert a claim for money damages arising from a breach of commercial contract . . . into a claim maintainable in equity by the expedient of asking that the defendant be enjoined from breaching such duty again.”

This decision is a useful reminder that boilerplate provisions such as arbitration clauses (and carveouts to those clauses) should be carefully considered in the context of any agreement, especially one relating to the sale of a business or other major transaction of a company.  While there may be varying opinions on the benefits of arbitration over litigation, once a path is chosen, the parties should carefully review these provisions to reduce ambiguity around any substantive and procedural issues that may arise.

If you have any questions about this topic, please feel free to email us.

Tags: acquisition, arbitration, corporate law, Delaware Chancery Court, delaware law, duty to defend, duty to indemnify, escrow, holdback, indemnification, indemnify, indemnity, reverse triangular merger, substantive arbitrability

A recent SJC decision involving a personal investment by Jack Welch in a failed Massachusetts hedge fund. The full decision can be read here.  Welch sued the fund and its manager for their failure to disclose that the manager was involved in a civil litigation (a landlord-tenant dispute over a former residency of the manager in New York), claiming that if he had known about that matter, he never would have invested.

The SJC upheld the summary judgment entered against Welch, holding that omission ultimately was not material enough to find the fund liable.
This case is interesting for its confirmation of certain provisions under the Massachusetts law on the following issues:

• The statutory standard of a misstatement or omission is material  under the Massachusetts Securities Act is whether there is a “substantial likelihood” that the omitted information would have “significantly altered the ‘total mix’ of information” available to the ordinary reasonable investor.
• A “material” fact is oneA “material” fact is one to which a reasonable person would attribute importance for his or her choice of action in the transaction at issue. Zimmerman v. Kent, 31 Mass.App.Ct. 72, 78 (1991).
• The court also held that if there is finding in this regard under the Uniform Securities Act, then there cannot be a finding that the actions were deceptive under Chapter 93A.
• The decision also provides a helpful summary of Massachusetts common law on fraud and negligent misrepresentation:
  • Intentional misrepresentation (or “deceit”): (a) an intentional or reckless (b) misstatement (c) of an existing fact (d) of a material nature, (e) causing intended reasonable reliance and (f) financial harm to the plaintiff.
  • Negligent misrepresentation: (a) a provision, in the course of the defendant’s business, profession, employment, or in the course of a transaction of his pecuniary interest, (b) of false information for the guidance of others in their business transactions, (c) without the exercise of reasonable care or competence in the acquisition or communication of the information, (d) causing justifiable reliance by, and (e) resulting in pecuniary loss to, the plaintiff.

If you have any questions about this topic, please feel free to email me directly.   My email address is dimitry.herman@hermanlawllc.com.

Tags: massachusetts supreme judicial court, Material fact, Securities law, seed investments, Unfair or deceptive act, Uniform Securities Act. Consumer Protection Act

In a major win for corporations worried about choice of law, the Delaware Court of Chancery held that forum selection bylaws adopted by corporation boards are at least facially valid as a matter of contract under Delaware General Corporation Law (DGCL). Boilermakers Local 154 Retirement Fund v. Chevron Corporation stands for the proposition that bylaws which designate a specific forum for legal dispute resolution will stand up in court, taking some of the concern away for corporations in the realm of multiforum litigation.

In the case at bar, both Chevron and FedEx had adopted bylaws in their certificates of incorporation which indicated that Delaware would be the sole forum for any stockholder litigation. The court rejected the plaintiffs’ challenge of these forum selection provisions and held that the DGCL in fact does permit this kind of forum designation contractually.

The court’s reasoning was in part that the DGCL permits corporations to regulate themselves in order to function smoothly, and these kinds of bylaws assisted the smooth governance of the corporation. The court also found that both federal and Delaware law rendered forum selection bylaws contractually enforceable. This finding is based on the fact that the charters of the corporations in question granted unilateral power to the boards to adopt bylaws, and that this binding power was known to stockholders.

If you have any questions about this topic, please feel free to email us.

Tags: articles of incorporation, Boilermakers Local 154 Retirement Fund, Chevron Corporation, choice of law, corporate bylaws, corporate governance, corporate law, Delaware Chancery Court, Delaware General Corporation Law, delaware law, DGCL, forum selection, multiforum litigation, stockholder litigation

A Massachusetts Appeals Court ruled today that an employee’s private right of action under the Massachusetts Wage Act under G.L. c. 149, § 148 did apply in the case of a traveling salesman who rarely set foot in the Commonwealth of Massachusetts. This choice of law case basically states that where the Commonwealth has a close connection to the employment relationship of the parties, local law should be applied to the claim.

In this case the plaintiff worked as a salesperson Starbak, Inc., a Delaware corporation that had its a sole place of business in Massachusetts. He resided in Florida and conducted most of his sales activity across the country for Starbal. When Starbak closed its doors, it terminated his employment with significant commissions outstanding. The plaintiff then brought suit against the company’s chief executive officer, a Massachusetts resident, seeking unpaid sales commissions of more than $100,000, certain unreimbursed expenses, wages in lieu of accrued vacation time, treble damages, and attorney’s fees. The question here was whether Massachusetts law would apply given that the plaintiff rarely visited the state.

The Court found that the nature of the plaintiff’s work was such that only Massachusetts was tied to it. The employment agreement governing the work relationship provided that Massachusetts law would be applied in the event of a dispute. Starbak was located there and as a result customers who dealt with the plaintiff entered into business with the company in Massachusetts. The plaintiff’s business cards identified his contact information as the same as Starbak’s, based in Massachusetts. His paychecks were issued from Massachusetts, and he communicated with the company daily. The plaintiff was in fact required to return to Massachusetts several times each year, and when he did return he would generally work in the same office space each time.

While distinguishing a case cited by the defendant where the Wage Act was not applied to an Australian employee operating outside the United States, importantly, the Court did acknowledge that the application of the Wage Act may be different in the case on a non-US employee.

This case should caution businesses that employ workers from a distance. While it does not seem to indicate that all remote employees will always be able to access remedies afforded by the local law of the businesses they work for, this is certainly something for businesses to consider when drafting employment agreements and establishing relationships with remote workers.

If you have any questions about this topic, please feel free to email us.

Tags: choice of law, corporate law, labor law, local law, massachusetts appeals court, Massachusetts law, Massachusetts Wage Act, remote employees