Director Compensation Amounts Must Be Approved by Stockholders to Avoid Entire-Fairness Review: Delaware Supreme Court Rejects “Meaningful Limits” Standard

By Jay McMillan

Although the Delaware General Corporation Law allows corporate boards of directors to set their own compensation (see 8 Del. C. § 141(h)), Delaware courts have found that, because those decisions are self-interested, they are subject to the stringent entire fairness standard of judicial review when challenged by stockholders. See Telxon Corp. v. Meyerson, 802 A.2d 257, 262 (Del. 2002). However, it has long been established that director self-compensation decisions can be “ratified” by an informed, uncoerced vote of disinterested stockholders, in which case they are reviewed under the deferential business judgment standard. See Kerbs v. Cal. E. Airways, Inc., 90 A.2d 652 (Del. 1952); Gottlieb v. Heyden Chem. Corp., 90 A.2d 660 (Del. 1960). Following recent opinions by the Delaware Court of Chancery, directors have been able to assert a ratification defense to claims of unfair compensation not only where the amounts were specifically approved by a stockholder vote, but also where the amounts were awarded under a stockholder-approved plan that set “meaningful limits” on director compensation. See Seinfeld v. Slager, 2012 Del. Ch. LEXIS 139, at *41 (Del. Ch. June 29, 2012).

In In re Investors Bancorp, Inc. Stockholder Litigation, 2017 Del. LEXIS 517, at *25 (Del. Dec. 13, 2017) (revised Dec. 19, 2017), the Delaware Supreme Court overruled the “meaningful limits” standard and reversed the Court of Chancery’s ruling in favor of the corporation’s directors, holding that where directors are given discretion to award their own compensation under a stockholder-approved plan, they must exercise that discretion in keeping with their fiduciary duties. Where a stockholder complaint adequately alleges a breach of fiduciary duty in the exercise of discretion after stockholder ratification of a plan, the complaint will survive a motion to dismiss.

The corporation, Investors Bancorp, Inc., was a publicly held bank holding company. The complaint asserted derivative claims against the corporation’s ten non-employee directors and two executive directors. It alleged that the non-employee directors were awarded an average of $2,100,000 each in stock options and restricted stock in 2015, compared with total compensation of between $97,200 and $207,005 each in 2014, and that their compensation “eclips[ed] director pay at every Wall Street firm.” The 2015 equity awards were made under an incentive plan that reserved approximately 9.3 million shares specifically for outside directors. In 2014, the company had sold approximately 220 million shares to the public at $10.00 per share. The plan provided that all of the reserved shares could be granted to the non-employee directors in any one year. The total value of the 2015 awards for all 12 non-employee and executive directors was approximately $51.5 million.

The Court of Chancery found that the plan contained “meaningful limits” because it contained limits specific to the non-employee directors. 2017 Del. Ch. LEXIS 53, at *23 (Del. Ch. Apr. 5, 2017). While acknowledging that the awards were “quite large,” the Court of Chancery rejected the plaintiffs’ argument that the Court should determine when limits set by a compensation plan are “meaningful,” stating that such a test “would propel the court into a position where it was second-guessing the informed decision of stockholders to approve compensation for the company’s directors and officers.” Id. at *25 n.33. Where fully informed stockholders ratify director compensation, the complaint will be dismissed unless the plaintiffs can invoke “the vestigial waste exception [which] has long had little real-world relevance, because it has been understood that stockholders would be unlikely to approve a transaction that is wasteful.” Id. (quoting Singh v. Attenborough, 137 A.3d 151, 151-52 (Del. 2016)).

The Delaware Supreme Court disagreed with the Court of Chancery, finding it “reasonably conceivable” based on the allegations of the complaint that the directors breached their fiduciary duties. The plaintiffs alleged that the awards were excessive compared to those made at peer companies and that, although the proxy statement suggested that the awards were to be made prospectively, the board made the awards based on past performance that had already been compensated. Based on those allegations, the Delaware Supreme Court found that the complaint stated a claim “that the directors breached their fiduciary duties in making unfair and excessive discretionary awards to themselves” and concluded “[b]ecause the stockholders did not ratify the specific awards the directors made under the [equity compensation plan], the directors must demonstrate the fairness of the awards to the Company.”

After Investors Bancorp, it is not sufficient that a stockholder-ratified plan sets “meaningful limits” or that it contains limits specific to outside directors. For directors to avoid entire-fairness review, stockholders must either ratify the “specific awards” or the awards must be made under “self-executing plans, meaning plans that make awards over time based on fixed criteria, with the specific amounts and terms approved by stockholders.” To avoid entire fairness review, either the specific amounts must be approved or the plan must leave no discretion to the directors in making awards.

Comment from my partner Mike Halloran:

       “It should not be suggested that stockholder approval or ratification of compensation paid to directors is either commonplace or necessary, because it is not. I recommend that, as directors cannot now rely on general wording to describe director compensation in compensation plans, they should be careful to consider appropriate information, such as compensation paid to directors of comparable companies, when approving compensation for themselves, to avoid the risk of having it reversed in an entire fairness trial.”

James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP. He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery. For more information on the firm, visit

Stock Reclassification that Perpetuated Majority Stockholder’s Control Approved by Delaware Court of Chancery

By Jay McMillan

Founders and majority stockholders who wish to raise capital by issuing additional stock may want to do so without relinquishing majority voting power, even after they no longer hold a majority of the corporation’s shares. They can maintain control by reclassifying the corporation’s stock so that that the controller’s stock has superior voting rights, often 10 times that of the common shares. Earlier this year, Facebook’s Mark Zuckerberg, who already held super-voting shares, proposed a plan under which newly issued shares would have no voting rights. Although similar plans had been successfully implemented by Alphabet (Google’s parent) and Snap Inc. (formerly Snapchat, Inc.), the Facebook plan was withdrawn in the face of litigation brought by the company’s stockholders in the Delaware Court of Chancery.

Another company that successfully reclassified its shares is NRG Yield, Inc., a Delaware corporation that owns a portfolio of income-producing assets in the energy generation and infrastructure fields. Its majority stockholder, NRG Energy, Inc., initially held 65% of the company’s stock, but the issuance of additional equity reduced its control to about 55%, and further equity sales would have eliminated NRG Energy’s majority control in a relatively short period. In May 2015, NRG Yield effected a stock reclassification under which new Class C and D shares were issued with only one one-hundreth of the voting power of the outstanding Class A and B shares. Because any new equity holders would have much lower voting power, NRG Energy would maintain its control of the vote much longer. The reclassification was negotiated and approved by a committee of independent directors and was conditioned on approval by a majority of stockholders unaffiliated with the controller.

In September 2016, an NRG Yield stockholder filed a class-action complaint in the Delaware Court of Chancery alleging that the company’s directors and NRG Energy as its controlling stockholder breached their fiduciary duties by approving the reclassification, based on the theory that NRG Energy received a benefit not shared with other stockholders by “perpetuating” its control of NRG Yield. In IRA Trust fbo Bobbie Ahmed v. Crane, 2017 Del. Ch. LEXIS 843 (Del. Ch. Dec. 11, 2017), Chancellor Andre G. Bouchard found that although NRG Energy did receive a unique benefit, which would make the transaction subject to the stringent entire fairness standard of review, the approval of a committee of independent directors and the fully informed, uncoerced vote of a majority of the minority stockholders made the transaction subject to the defendant-friendly business judgment standard of review, and required dismissal of the complaint.

The Court applied the “MFW” standard established by the Delaware Supreme Court in Kahn v. M&F Worldwide Corp., 88 A.3d 635 (Del. 2014). Under MFW the business judgment standard applies to a conflicted transaction if six elements are present:

(i) the controller conditions the procession of the transaction on the approval of both a Special Committee and a majority of the minority stockholders; (ii) the Special Committee is independent; (iii) the Special Committee is empowered to freely select its own advisors and to say no definitively; (iv) the Special Committee meets its duty of care in negotiating a fair price; (v) the vote of the minority is informed; and (vi) there is no coercion of the minority.

88 A.3d at 645. MFW involved a merger transaction. The Court in Crane rejected the plaintiff’s argument that the MFW standard should apply only to mergers, stating “I see no principled reason why that rationale would not apply equally to other conflicted controller transactions.”

Crane represents a step in the “evolution” of the MFW doctrine, making it clear that the standard is not limited to mergers, but also provides a roadmap for other conflicted transactions with controlling stockholders. Specifically, in the case of stock reclassifications that prolong or perpetuate a majority stockholder’s control, a Delaware corporation can ensure favorable review if the transaction is conditioned from the outset on the approval of a special committee of independent directors with a mandate that allows it to freely select its own legal and financial advisors, to meet its duty of care in negotiating with the majority stockholder, and to definitively say no, and on the informed, uncoerced vote of a majority of the minority stockholders.

James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP. He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery. For more information on the firm, visit

Delaware Court of Chancery Slams Plaintiffs’ Firm for Using “Ostensible” Stockholder Plaintiff in Books and Records Action

By Jay McMillan

The Delaware Court of Chancery has held, apparently for the first time, that the requisite “proper purpose” in a books and records action must be the stockholder’s own purpose and not one devised by the stockholder’s lawyers. Based on the Court’s ruling in Wilkinson v. A. Schulman, Inc., C.A. No. 2017-0138-JTL, 2017 Del. Ch. LEXIS 798 (Del. Ch. Nov. 13, 2017), stockholder plaintiffs in books and records actions will be required to have “substantive involvement” in the litigation – a requirement that does not exist in stockholder class-action and derivative cases.

The Delaware Supreme Court has urged stockholder plaintiffs to use the “tools at hand,” in particular the right to inspect and copy corporate books and records under Section 220 of the Delaware General Corporation Law, to investigate potential claims before bringing plenary actions challenging corporate transactions. See Rales v. Blasband, 634 A.2d 927, 934 n.10 (Del. 1993); Grimes v. Donald, 673 A.2d 1207, 1216 & n.11 (Del. 1996). However, where a stockholder in a Delaware corporation seeks inspection of the corporation’s books and records, other than its stock ledger or list of stockholders, Section 220 requires the stockholder to establish that the inspection sought is “for a proper purpose,” defined as “a purpose reasonably related to such person’s interest as a stockholder.” In Wilkinson, the Delaware Court of Chancery has found that the required proper purpose must be the stockholder’s own purpose and not one devised by the stockholder’s counsel.

Based on a stockholder plaintiff’s admission that his stated purpose for inspection was his counsel’s invention and not his own, the Court granted judgment in favor of the corporate defendant and against the stockholder following a bench trial. In Wilkinson, Vice Chancellor J. Travis Laster rejected the plaintiff’s books and records demand based on his finding that the plaintiff’s stated purpose for inspection was not his true purpose.

The plaintiff, represented by the New York firm Levi & Korsinsky, LLP (“L&K”), sought inspection of the books and records of plastics maker A. Schulman, Inc. for the stated purpose of investigating a decision by the corporation’s board of directors to accelerate the vesting of shares of restricted stock, valued at more than $3.9 million, for the corporation’s president and chief executive officer upon his retirement at the end of 2014. However, the plaintiff testified that he contacted L&K because he was concerned with the corporation’s November 2016 announcement of a loss of $365 million following the acquisition of another plastics company. The plaintiff testified that he was not aware of any impropriety concerning the 2014 compensation award.

The Court found that “Wilkinson simply lent his name to a lawyer-driven effort by entrepreneurial plaintiffs’ counsel” and that he “did not take any steps to confirm the accuracy of the allegations in the complaint,” did not read the corporation’s answer to the complaint, and did not participate in drafting answers to interrogatories, but rather verified the complaint and interrogatory answers in reliance on his counsel.

The Court may have been influenced by the fact that Wilkinson was a serial plaintiff. The Court noted that Wilkinson had been a plaintiff in at least seven L&K lawsuits, “most of which challenged mergers,” that he “did not do anything to verify the factual allegations in those lawsuits, other than to read the complaints that L&K drafted,” that he “agreed to serve as a plaintiff reflexively after seeing the press releases L&K issued announcing investigations into the transactions,” and that he participated “because he wanted more money for his shares, regardless of whether the deal price was fair,” that he “never received a dime of additional consideration,” and that “most, if not all, of the cases settled for supplemental disclosures.” The Court did not, however, suggest that Wilkinson had been found to be an inadequate stockholder representative in any of those seven cases.

The Court emphasized that it is advisable for stockholders seeking inspection of corporate books and records to retain experienced counsel, but stated that “retaining counsel to carry out the stockholder’s wishes is fundamentally different than having an entrepreneurial law firm initiate the process, draft a demand to investigate different issues than what motivated the stockholder to respond to the law firm’s solicitation, and then pursue the inspection and litigate with only minor and non-substantive involvement from the ostensible stockholder principal.”

The Court’s decision in Wilkinson reflects some of the obstacles that may confront a stockholder bringing a books and records action. The opinion suggests that stockholder plaintiffs in books and records actions must act on their own initiative with a proper purpose in mind and that they must have substantive involvement in the litigation. In a plenary class or derivative action, there is no “proper purpose” requirement, and the only statutory requirement under Delaware law is that the plaintiff in a derivative action must have held shares at the time of the challenged transaction. See 8 Del. C. § 327. The Court has never required class-action or derivative plaintiffs to be self-motivated or have substantive involvement in litigation. Thus, based on Section 220’s “proper purpose” requirement, the Court of Chancery would appear to require more from a books and records plaintiff seeking to use the “tools at hand” to investigate a transaction than it would require of the same plaintiff bringing a plenary action challenging the same transaction without first bringing a Section 220 action.

James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP. He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery. For more information on the firm, visit

Delaware Supreme Court Sends Plaintiffs to Bring Suit in Bulgaria, Establishes Intermediate Standard for First-Filed Cases

By Jay McMillan

Although Delaware is the preferred jurisdiction for deciding business disputes, it sometimes happens that a defendant would prefer to litigate elsewhere. When that happens the defendant may move to dismiss the action based on forum non conveniens, that is, because the forum is not convenient to the defendant. The decisive factor in such cases is whether there is a prior-filed action pending in another jurisdiction. Delaware courts typically rule in favor of the first-filed action. Where the Delaware action is first-filed, to prevail on a motion to dismiss, the defendant must show that it would suffer “overwhelming hardship” from being forced to litigate in Delaware. Where a prior-filed action is pending in another jurisdiction, a Delaware court will grant the motion to dismiss if the other action involves the same parties and the same issues and was brought in a court capable of doing prompt and complete justice. Either way, the prior-filed action is favored.

A less common scenario arises when a prior-filed action has been brought in another jurisdiction but is no longer pending. In a recent Delaware Supreme Court case, Gramercy Emerging Markets Fund v. Allied Irish Banks, p.l.c., 2017 Del. LEXIS 452 (Del. Oct. 27, 2017), the plaintiffs, a Cayman Islands company and two Delaware subsidiaries, had first brought suit in Illinois against the defendants, a bank organized under Delaware law with offices in Illinois and Bulgaria, and an Irish bank based in Dublin. The claims were brought under Bulgarian law. The Illinois court dismissed the complaint based on forum non conveniens. The plaintiffs then filed suit in the Delaware Court of Chancery, where Vice Chancellor Sam Glasscock III granted the defendants’ motions to dismiss on the same grounds.

The Delaware Supreme Court affirmed, finding that the plaintiffs’ claims “involve important and unsettled issues of Bulgarian securities law arising out of an investment in a Bulgarian bank” and that the plaintiffs knew from the start that they were investing in a Bulgarian bank governed by Bulgarian law.

Forum non conveniens standards: Cryo-Maid and McWane

Where the Delaware case is first-filed, Delaware courts apply a plaintiff-friendly standard based on General Foods Corp. v. Cryo-Maid, Inc., 198 A.2d 681 (Del. 1964) which requires a defendant to show that it would suffer “overwhelming hardship” from being forced to litigate in Delaware. This is because Delaware courts are reluctant “to lightly disturb a plaintiff’s first choice of fora.” Under Cryo-Maid, the court considers five factors: “(1) [t]he relative ease of access to proof; (2) the availability of compulsory process for witnesses; (3) the possibility of the view of the premises, if appropriate; . . . (4) all other practical problems that would make the trial of the case easy, expeditious and inexpensive;” and (5) “whether or not the controversy is dependent upon the application of Delaware law which the courts of this State more properly should decide than those of another jurisdiction.” The court also considers a sixth factor, whether or not there is a similar action pending in another jurisdiction.

Where the Delaware case is not the first-filed case and the earlier case is pending in another jurisdiction, the analysis favors the defendant (who is typically the plaintiff in the other, first-filed case) and the court applies a defendant-friendly standard based on McWane Cast Iron Pipe Corp. v. McDowell-Wellman Engineering Co., 263 A.2d 281 (Del. 1970). Under McWane, dismissal is within the court’s discretion and is strongly favored where: “(1) [there is] a prior action pending elsewhere; (2) in a court capable of doing prompt and complete justice; (3) involving the same parties and the same issues.”

In another, more recent case, Lisa, S.A. v. Mayorga, 993 A.2d 1042 (Del. 2010), three actions that the plaintiff had filed in Florida had been dismissed, one of them on the merits with prejudice, so there was no prior-filed case pending elsewhere. The Court of Chancery applied the Cryo-Maid factors and found that litigating in the alternative forum (Guatemala) would cause the defendant “overwhelming hardship.” The Delaware Supreme Court affirmed, but did so under McWane, finding that the fact that the Florida action was no longer pending did not change the outcome, and that McWane should apply because the plaintiff-friendly standard of Cryo-Maid “would ignore the binding effect of the Florida adjudication, and create the possibility of inconsistent and conflicting rulings.” Allowing the plaintiff to proceed in Delaware after dismissal on the merits in Florida would be “precisely the outcome McWane’s doctrine of comity seeks to prevent.”

In Gramercy, however, the prior-filed action was dismissed not on the merits, but on procedural grounds, without prejudice. Therefore, the Court of Chancery treated the Delaware action as first-filed and applied the plaintiff-friendly Cryo-Maid standard. However, the Court found in favor of the defendants, granting their motions to dismiss without finding that they would suffer overwhelming hardship. On appeal, the plaintiff argued that the Court of Chancery should have applied the overwhelming hardship standard. The Delaware Supreme Court rejected that argument and affirmed the Court of Chancery’s ruling in favor of the defendants. In addition, the Supreme Court clarified “the spectrum of standards under which motions for forum non conveniens are considered in Delaware.” The Court established an “intermediate” standard, concluding that “when a case is later-filed and its predecessors are no longer pending, the analysis is not tilted in favor of the plaintiff or the defendant. In that situation, Delaware trial judges exercise their discretion and award dismissal when the Cryo-Maid factors weigh in favor of that outcome.”

The Delaware Supreme Court found that its earlier ruling in Lisa was “case-specific.” In Lisa, the Court of Chancery ruled in favor of the defendant even under the plaintiff-friendly Cryo-Maid standard. Had Lisa been decided by balancing the Cryo-Maid factors under the neutral standard prescribed by Gramercy, without the overwhelming hardship “overlay,” rather than under the defendant-friendly McWane standard used by the Delaware Supreme Court in that case, the outcome would have been the same.

James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP. He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery. For more information on the firm, visit

Plaintiff who Alleged that Corporation “Illegally Committed” Patients to Mental-Health Facilities Can’t Cherry-Pick Documents

By Jay McMillan

In drafting a complaint, an attorney might rely on a document “in isolation, not in bad faith but perhaps over-zealously in the belief that the document reveals more than it does.” Amalgamated Bank v. Yahoo! Inc., 132 A.3d 752, 799 (Del. Ch. 2016). Ordinarily, a defendant responding to such a complaint in a Delaware state court could be frustrated by the rule that blocks the defendant from introducing other documents in the same context unless they are specifically incorporated by reference in the complaint. But that rule does not always apply.

In several recent cases involving stockholder demands for inspection of corporate books and records, the Delaware Court of Chancery has approved an “incorporation condition” providing that all documents produced by the corporation in response to such a demand are incorporated into any subsequent derivative complaint filed by the stockholder against the corporation’s directors on behalf of the corporation. Ordinarily, a defendant may only move to dismiss a complaint based on the insufficiency of the complaint itself and the documents incorporated by reference in the complaint. In other words, at the pleading stage a defendant may not refute the plaintiff’s documents with other documents of its own. However, where an incorporation condition applies, the defendant may use any of the documents it produced to the stockholder plaintiff in response to a books-and-records demand. A recent case, City of Cambridge Retirement System v. Universal Health Services, Inc., C.A. No. 2017-0322-SG (Oct. 12, 2017), solidifies the use of incorporation conditions in books-and-records cases.

In that case, the corporation, UHS, agreed to produce documents in response to a stockholder demand only if the stockholder entered into a confidentiality agreement with an incorporation condition. The stockholder refused and brought a books-and-records action in the Court of Chancery under Section 220 of the Delaware General Corporation Law, seeking production of the documents free of the incorporation condition.

Although the allegations against UHS were sensational, Vice Chancellor Sam Glasscock III found in UHS’s favor on the narrow issue of the incorporation provision. The plaintiff alleged that UHS illegally committed patients to behavioral health facilities by luring them in with “advertisements for free wellness examinations … [and] trick[ing] patients into implying they harbored suicidal thoughts,” keeping them in the facilities “until their insurance benefits ran out.” The Court in a footnote pointed out that UHS “stoutly denied” the allegations, but “If true, in addition to being morally despicable behavior by the individuals responsible, this would represent the worst abuse of a Delaware corporate franchise of which I am aware.”

The plaintiff argued that incorporation provisions are “pernicious” because they allow companies to “manipulate” their document productions “without any punishment for failing to produce [harmful] documents.” Although the Court pointed out that the same argument could be made about a corporation’s ability to manipulate the record available to a plaintiff through discovery on a motion for summary judgment, the plaintiff argued that a stockholder making a Section 220 demand “has substantially less ability to test the sufficiency of production, compared with a litigant receiving discovery.” The Court rejected that argument, concluding that “the benefits of allowing the court to eliminate complaints involving misleading citations to a limited subset of records” outweighed “the risk of potential malfeasance” by producing defendants.

The Court stressed that the standard on a motion to dismiss in Delaware “remains plaintiff-friendly” – a complaint survives unless the plaintiff could not prevail based on any “reasonably conceivable” set of facts inferable from the complaint. The Court expressed confidence in its ability, “through proper application of that standard [to] eliminate much of the risk of gamesmanship and improper dismissal.”

The Court found that the plaintiff in UHS had failed to distinguish the previous cases in which the Court had approved incorporation conditions. Those cases, along with UHS, make incorporation conditions virtually the norm in books and records cases. After UHS, Stockholders making books-and-records demands and corporations confronted with them should both anticipate that any production will be subject to a confidentiality agreement that includes an incorporation condition.

James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP. He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery. For more information about the firm, visit

Directors May Not Knowingly Allow a Corporation to Violate the Law

By Jay McMillan

The Delaware Court of Chancery has found that corporate directors breach their duty of good faith if they knowingly allow their corporation to violate positive law, for profit or otherwise.[1] Directors of Delaware corporations can be held personally liable for fines and other damages resulting from known violations of law. In Kandell v. Nviv, Civil Action No. 11812-VCG (Sept. 29, 2017), the stockholder plaintiff brought a derivative action against the directors of FXCM, Inc., a “foreign exchange broker” engaged in the business of buying and selling foreign currencies on customers’ orders. Industry practice was that customers’ trades were highly leveraged, but FXCM distinguished itself by promising clients that it would not attempt to collect on their losses beyond the relatively small amounts they invested. That policy at first led to significantly higher revenues.

The Corporation’s Violations of Law

However, rules promulgated by the United States Commodity Futures Trading Commission (CFTC) in connection with the Dodd-Frank Act of 2010 prohibit foreign exchange traders such as FXCM from representing that they will limit their clients’ trading losses. According to the plaintiff, FXCM’s board knowingly allowed the corporation to violate 17 C.F.R. (Code of Federal Regulations) § 5.16 (Regulation 5.16). The directors’ knowledge was evidenced by the company’s public filings, which disclosed a “risk” that Regulation 5.16 forbade making guarantees against loss to retail foreign exchange customers. The directors were thus aware of Regulation 5.16 and of the company’s advertised policy of not pursuing customer losses beyond the investment amount.

The policy eventually led to catastrophic losses for FXCM. On January 15, 2015, the Swiss National Bank announced that it would allow the Swiss franc to “float freely” against the euro, leading to a “Flash Crash.” In the 45 minutes following the announcement, FXCM customers “locked in” losses of $276 million, which FXCM was unable to collect because of its liberal policy regarding customer losses.

The Complaint and the Court’s Ruling

The derivative complaint, initially filed in December 2015, sought damages from the directors on behalf of the corporation for losses incurred in the Flash Crash. The defendants moved to dismiss the complaint, arguing that while they knew of Regulation 5.16 and of the corporation’s policy, they did not know that the policy violated Regulation 5.16.

Denying the motions to dismiss, Vice Chancellor Glasscock looked to the text of Regulation 5.16, which provides that no retail foreign exchange dealer may “guarantee” a customer against loss or “Limit the loss of such person.” The Court found that “the Regulation itself, on my reading, clearly prohibits touting loss limitations to clients, and I find that the Company did precisely that.” The Court stated that “my reading of Regulation 5.16 is sufficient at the pleadings stage to infer scienter” on the part of the board. Because the Regulation clearly prohibited the corporation’s conduct, the Court inferred that the directors were aware that the corporation was in violation of Regulation 5.16. The Court emphasized that the case presented “a highly unusual set of facts” in which a corporation’s business model relied on “a clear violation of a federal regulation” of which it could be inferred that the board had knowledge.

The Court noted that this case did not involve a typical Caremark claim because it did not involve “a director’s bad-faith failure to exercise oversight over the company” to ensure that violations of law did not occur, but rather involved violations of law that were actually known to the directors. In Caremark, the Court of Chancery approved a settlement because it found that the record did not “tend to show knowing or intentional violation of law” by the director defendants. In re Caremark International, Inc. Derivative Litigation, 698 A.2d 959, 961 (Del. Ch. 1996). Neither Caremark nor FXCM involved a mere breach of the duty of care that could be exculpated by a corporate charter provision under Section 102(b)(7) of the Delaware General Corporation Law. The statute expressly excludes exculpation for “acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law.” 8 Del. C. § 102(b)(7).[2]

Practice Pointers

Attorneys advising boards of directors should stress that corporate directors may not tolerate known violations of law, including regulatory law, even if it might make economic sense to do so in the board’s exercise of its business judgment. In the case of FXCM, the corporation may have taken a risk in violating the law that proved disastrous in a crisis. As the Court stated, “Where directors intentionally cause their corporation to violate positive law, they act in bad faith…. a fiduciary of a Delaware corporation cannot be loyal to a Delaware corporation by knowingly causing it to seek profits by violating the law.”

[1] According to Wikipedia, positive law consists of “human-made laws that oblige or specify an action,” from the verb “to posit,” as opposed to “natural law.”

[2] Exclusions for illegal conduct or violation of law, and possibly bad faith, would typically apply to directors’ and officers’ insurance policies as well.

James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP. He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery. For more information on the firm, visit

Another Good Reason Not to Oppose a Motion to Amend a Pleading in the Delaware Court of Chancery

By Jay McMillan

For good reason, it is unusual for a party in litigation in the Delaware Court of Chancery to oppose a motion to amend a complaint or other pleading. Under the Court’s Guidelines to Help Lawyers Practicing in the Court of Chancery (available here), parties are urged to agree to the filing of amended pleadings, but may reserve the right to file motions to dismiss the amended pleadings once filed. Following that procedure, the party opposing the amended pleading on a motion to dismiss (typically the defendant) gets to submit two briefs, one opening brief in support of the motion to dismiss and a reply brief in response to the plaintiff’s opposition brief. If the defendant chooses to oppose the amendment at the outset, it gets only one brief, an answering brief in opposition to the plaintiff’s motion to amend. Since two briefs are better than one, the defendant will typically follow the Court’s Guidelines and stipulate to the amendment, then move to dismiss the amended pleading. From the Court’s point of view, this procedure also precludes the defendant from taking two bites at the apple by first opposing the motion to amend, then filing a motion to dismiss if the plaintiff’s motion to amend is granted.

A motion to amend can be denied where amendment would be futile, that is, where the amended pleading would be dismissed under Rule 12(b)(6) for failure to state a claim upon which relief could be granted. Unless the party opposing amendment demonstrates that it will be prejudiced, a motion to amend may be reviewed under the same standard as a motion to dismiss. See Paine Webber v. Centocor, 1997 WL 30216, at *1, *3 (Del. Ch. Jan. 15, 1997) (Steele, V.C.). A defendant that stipulates to a motion to amend may thus assume that the standard for futility of amendment is the same as that for a motion to dismiss under Rule 12(b)(6).

A recent, unusual case provides another reason not to oppose a motion to amend a pleading, because there may in fact be a difference in the standards for futility of amendment and failure to state a claim. In a Final Report issued on September 22, 2017, in Apogee Investments, Inc. v. Summit Equities LLC, Civil Action No. 12897-MZ, Master in Chancery Morgan Zurn recommended that the Court grant a stockholder’s motion to amend a complaint in a books-and-records action. Master Zurn quoted NACCO Industries, Inc. v. Applica, Inc., 2008 WL 2082145, at *1 (Del. Ch. May 7, 2008), for the principle that a motion to amend may be denied under Court of Chancery Rule 15(a) “if the amendment would be futile, in the sense that the legal insufficiency of the amendment is obvious on its face.”

In Delaware, “legal insufficiency” under Rule 12(b)(6) occurs when relief could not be granted under any “reasonably conceivable” set of circumstances. See Central Mortgage v. Morgan Stanley Mortgage Capital Holdings, 27 A.3d 531, 536-37 (Del. 2011). If a motion to amend can only be denied where legal insufficiency is “obvious on its face,” that presents a lower hurdle for a motion to amend. Thus, it is possible for an amendment to clear the hurdle for a motion to amend and not clear the hurdle for a motion to dismiss. While the legal insufficiency of an amendment may not be “obvious on its face,” it may appear upon closer scrutiny on a motion to dismiss.

Given that the Court may be less receptive to a defendant’s motion to dismiss after it has granted a motion to amend over the defendant’s opposition, the defendant would be well advised to stipulate to the amendment and present its opposition to the amended complaint where the plaintiff faces the higher hurdle, on a motion to dismiss. Delaware’s “reasonably conceivable” standard is a low enough hurdle for a pleading party; legal insufficiency being “obvious on its face” is even lower. In Apogee Investments, Master Zurn found that the allegations of the proposed amendment were not “so obviously deficient on their face as to be deemed futile.” She concluded that the defendant’s opposition to the proposed amendment failed to overcome the “compounded liberal standards” for a motion to amend.

In short, it does not pay to oppose a motion to amend a pleading in the Delaware Court of Chancery. The Court may apply an extremely liberal standard to the motion, the opposing party is limited to a single brief in opposition to the motion, and the opposing party may be less likely to prevail on a subsequent motion to dismiss than it would be if it had stipulated to the amendment and reserved the right to move to dismiss.


James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP. He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery. For more information on the firm, visit

Delaware Court of Chancery Places Biological and Non-Biological Persons on the Same Footing Regarding Trial Testimony

By Jay McMillan

Where one party to a lawsuit is a business entity or other organization, the other party to the lawsuit may take the organization’s pre-trial deposition testimony on specified topics by questioning a witness designated by the organization. Rule 30(b)(6) of the Delaware Court of Chancery Rules (like Rule 30(b)(6) of the Federal Rules of Civil Procedure) requires the designated person to testify as to matters “known or reasonably available to the organization.” That means that the organization must designate a human witness who already possesses the organization’s “institutional knowledge” or it must educate a witness to the point that he or she is able to so testify.

It sometimes happens, however, that the designated witness lacks complete knowledge of the specified topics and is unprepared to testify or, worse yet, that the witness’s knowledge is inconsistent with the organization’s true institutional knowledge. The question then arises whether the organization should be bound by the witness’s deposition testimony or whether it should be allowed to supplement or correct the testimony at trial.

In ADT Holdings, Inc. v. Harris, C.A. No. 2017-0328-JTL (Del. Ch. Sept. 7, 2017), Vice Chancellor J. Travis Laster of the Delaware Court of Chancery ruled that organizations, or “non-biological persons,” should have the same opportunities to correct or supplement their testimony as “biological persons.” In ADT Holdings the plaintiffs filed a pre-trial motion in limine seeking to preclude the corporate defendant from offering evidence that “contradicts or seeks to expand” the deposition testimony of its designated witness. The plaintiffs urged the Court to adopt the view held by a minority of federal courts that treat Rule 30(b)(6) testimony as “something akin to a judicial admission—a statement that conclusively establishes a fact and estops an opponent from controverting the statement with any other evidence.” Id. at 2 (quoting State Farm Mut. Auto. Ins. Co. v. New Horizons, Inc., 250 F.R.D. 203, 212 (E.D. Pa. 2008)). Those courts have concluded that binding organizations to their Rule 30(b)(6) testimony prevents them “from thwarting inquiries during discovery, then staging an ambush during a later phase of the case.” Id. at 3 (quoting Rainey v. Am. Forest & Paper Ass’n, Inc., 26 F. Supp. 2d 82, 95 (D.D.C. 1998)).

Vice Chancellor Laster rejected the plaintiffs’ argument, instead adopting the view of a majority of federal courts that allow a Rule 30(b)(6) designated witness to “testify differently from the way he or she testified in a deposition, albeit at the risk of having his or her credibility impeached by the introduction of the deposition.” Id. at 4 (quoting R & B Appliance Parts, Inc. v. Amana Co., 258 F.3d 783, 786 (8th Cir. 2001)). The Court noted that allowing an organization to contradict the testimony of its own 30(b)(6) witness is consistent with Delaware Rule of Evidence 607 and its federal analog, which allow a witness’s credibility to be “attacked by any party, including the party calling him.”

The Court found that the purpose of Rule 30(b)(6) is “to afford comparable treatment to biological and non-biological persons” and place them “on the same footing” by allowing them to contradict their own testimony, only at the risk of losing credibility.

As a court that conducts only bench trials, and not jury trials, it is not surprising that the Court of Chancery would allow broad leeway in admitting evidence at trial, including evidence to contradict or supplement Rule 30(b)(6) testimony, relying on its own judgment to assign credibility to witnesses at trial. The lesson for corporations and other organizations in litigation is that, although they may be able to supplement or correct their testimony, they should thoroughly prepare their Rule 30(b)(6) witnesses so as to avoid loss of credibility at trial. The lesson for the other side is never to be satisfied with an unprepared Rule 30(b)(6) witness because the organization may be allowed to supplement the witness’s testimony at trial.


James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP. He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery. For more information on the firm, visit

Delaware Court of Chancery Dismisses Case After Trial for Lack of Personal Jurisdiction; No Contract Where “Essential” Schedule Was Left Blank

By Jay McMillan

When a defendant contests a court’s personal jurisdiction, the defendant may file a motion to dismiss the action under Rule 12(b)(2) of the Federal Rules of Civil Procedure or its state-court analog. Such a motion is typically decided before the court considers the merits of the plaintiff’s claims. If the court determines that it lacks personal jurisdiction, the case is dismissed at the outset and the plaintiff must seek relief in another jurisdiction that may have personal jurisdiction over the defendant.

One basis for a court’s personal jurisdiction is a forum selection clause under which the parties to a contract consent to the personal jurisdiction of the courts of a specified jurisdiction. However, if the alleged contract is not valid and binding on the parties, and there is no other basis for personal jurisdiction, the specified courts cannot exercise jurisdiction over the defendant.

In Eagle Force Holdings, LLC v. Campbell, C.A. No. 10803-VCMR (Del. Ch. Sept. 1, 2017), Vice Chancellor Tamika Montgomery-Reeves of the Delaware Court of Chancery found it necessary to conduct a trial to determine whether the document executed by the parties, which contained a forum selection clause, was a valid and binding contract. Following trial, she found that the parties did not enter into a valid and binding contract and dismissed the action under Court of Chancery Rule 12(b)(2) for lack of personal jurisdiction over the defendant. It was necessary for the Court to decide the merits of the case in order to resolve the jurisdictional issue.

The defendant, Stanley Campbell, developed “certain medical diagnosis and prescription technology.” Mr. Campbell and Mr. Richard Kay “decided to form a business venture” to market Campbell’s technology. Kay contributed cash and Campbell contributed the intellectual property. The two men “outlined the principal terms of the investment through two letter agreements,” and subsequently entered into a contribution agreement and an operating agreement to form a Delaware limited liability company, Eagle Force Holdings, LLC. The contribution agreement and the operating agreement both contained Delaware forum selection clauses.

Although the parties clearly had formed a business venture together, Campbell argued that the agreements were not valid and binding because the parties did not agree on certain “essential” terms, including the consideration he would contribute to the new company. The “precise scope” of the consideration was to be “captured” by two sections of the contribution agreement and four schedules to that agreement, but those portions were “either blank or inconsistent with the reality” known to the parties. For example, Campbell was to contribute all of the equity in two Virginia companies, but it was unclear whether some of that equity was held by the companies’ employees, so the schedule that would specify Campbell’s equity contributions was left blank (except for a bracketed reference to an employee equity participation plan).

The Court found that the parties “recognized that Campbell likely does not own 100% of the equity” in the two Virginia companies and had not obtained releases from the employees. Although the parties were aware of the problem, “they did not come to agreement on terms that addressed the reality.” The term was “material” to the parties because it bore on whether the two men would have equal equity and control in the new company. Because the parties had not completed negotiations on terms they considered “essential,” the Court ruled that they had not entered into a binding contract.

The Court also found based on the record at trial that Campbell did not “actively participate in the management of a Delaware limited liability company” and therefore was not subject to personal jurisdiction under Section 18-109 of the Delaware Limited Liability Company Act.

In this “unusual” business divorce case, although the action was dismissed for lack of personal jurisdiction, the plaintiff will not have a viable opportunity to pursue the defendant in another jurisdiction (for example, Virginia) because the substantive claims for breach of contract have already been decided – there was no valid and binding contract. The moral of the story: when signing a contract, take your time and make sure none of the schedules is left blank.


James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP. He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery. For information on the firm, visit

A Colorable Claim of Privilege Triggers a Duty to Alert Opposing Counsel of Inadvertently Produced Documents

By Jay McMillan

Every litigation attorney has reviewed documents produced by adverse parties in discovery, and many of us have had the experience of finding an attorney-client privileged document that was inadvertently produced by the other side. We generally assume that we are under an ethical obligation, or required by court rules, or both, to notify the producing party of the inadvertent production and perhaps to return or destroy the documents. However, ethical rules and court rules vary, and they provide little or no guidance for determining whether a particular document should be considered privileged. The Delaware Court of Chancery has recently expressed its view: lawyers should not weigh the arguments for and against privilege or rely on the strength of their own arguments; they should notify the producing party of the inadvertent production if a colorable argument could be made for privilege.

The American Bar Association’s Model Rules of Professional Conduct (which do not apply in Delaware) provide: “A lawyer who receives a document or electronically stored information relating to the representation of the lawyer’s client and knows or reasonably should know that the document or electronically stored information was inadvertently sent shall promptly notify the sender.” (Rule 4.4(b)).

While “relating to the representation of the lawyer’s client” is broad, the ABA has not provided any guidance for determining whether a document “relates” to the representation.

In Delaware, the Superior Court’s Complex Commercial Litigation Division has a Protocol for the Inadvertent Production of Documents that requires the recipient of “privileged or confidential information or documents” that the recipient “believes were produced inadvertently” to either return the materials to the producing party or notify the producing party of the apparent inadvertent production.

However, the Protocol does not define “privileged or confidential” and does not provide any guidance for determining whether a document is privileged.

For lawyers practicing in the Delaware Court of Chancery, neither the Court’s rules nor the Delaware Lawyers’ Rules of Professional Conduct require a party to notify another party of receipt of inadvertently produced materials. The Court of Chancery’s sample confidentiality stipulation (available on its website) requires a receiving party to refrain from use of, and return or destroy inadvertently produced materials upon notice from the producing party, but it does not require the receiving party to give notice to the producing party.

However, the Court appears to expect it, and to expect a receiving party to give notice if the producing party “might” have a “colorable claim” of privilege. In an oral ruling in Zohar II 2005-1, Ltd. v. FSAR Holdings, Inc., C.A. No. 12946-VCS (Del. Ch. June 7, 2017), Vice Chancellor Joseph R. Slights III gave guidance for determining whether a document should be considered privileged. The Court stated that “under this Court’s precedent … plaintiffs’ counsel’s duty to alert defense counsel is triggered in any instance where a document inadvertently produced is subject to even a ‘colorable claim’ of privilege.” The Court stated “counsel doesn’t get to make its privilege call but must instead allow opposing counsel to be heard on the issue whenever even a colorable claim of privilege might be asserted.” The Court defined a “colorable claim” as “one that has a reasonable chance of succeeding” or “a claim worthy of serious consideration.”

The Court in Zohar found that, although the document in question did not convey any legal analysis or strategy, the Court could “certainly see an argument that the purpose of the communication was to facilitate the rendition of professional legal services to the client.” The Court further stated “we don’t want attorneys making close judgment calls on privilege themselves, hoping that a Court will agree with their privilege analysis after the fact, even if there are potentially good arguments to defeat the privilege or strong arguments that the privilege has been waived, both of which exist here.”

Based on the Court’s ruling, even if the receiving lawyer sees strong arguments that the document is not privileged or that the privilege has been waived, the lawyer must notify the producing party of the potentially inadvertent production.


James G. (Jay) McMillan is a partner in the Wilmington, Delaware office of Halloran Farkas + Kittila LLP. He concentrates his practice in complex corporate and commercial matters, with a particular focus on litigation in the Delaware Court of Chancery. For more information on the firm, visit