Developments in Securities Regulation, Corporate Governance, Capital Markets, M&A and Other Topics of Interest. MORE

Most are familiar with the facts of the crashes of Boeing’s 737 MAX.  Later Boeing stockholders brought a claim that Boeing’s directors failed them in overseeing mission-critical airplane safety to protect enterprise and stockholder value.  The Delaware Court of Chancery issued an opinion that these Caremark claims survived a motion to dismiss.

The Court noted that at the pleading stage, a plaintiff must allege particularized facts that satisfy one of the necessary conditions for director oversight liability articulated in Caremark, either that:

  • the directors utterly failed to implement any reporting or information system or controls; or
  • having implemented such a system or controls, the directors consciously failed to monitor or oversee its operations thus disabling themselves from being informed of risks or problems requiring their attention.

The Court explained Caremark does not constitute a freestanding fiduciary duty that could independently give rise to liability.  A showing of bad faith is a necessary condition to director oversight liability.  In re Walt Disney Co. Derivative Litigation established that the intentional dereliction of duty or conscious disregard for one’s responsibilities, that is more culpable than simple inattention or failure to be informed of all facts material to the decision, reflects that directors have acted in bad faith and cannot avail themselves of defenses grounded in a presumption of good faith. Accordingly, in order to plead a derivative claim under Caremark, a plaintiff must plead particularized facts that allow a reasonable inference the directors acted with scienter which in turn requires proof that a director acted inconsistently with her fiduciary duties, but also that the director knew she was so acting.

Throughout the opinion the court looked to the precedent in MarchandMarchand addressed the regulatory compliance risk of food safety and the failure to manage it at the board level, which allegedly allowed the company to distribute mass quantities of ice cream tainted by listeria. Food safety was the “most central safety and legal compliance issue facing the company.” In the face of risk pertaining to that issue, Marchand noted the board’s oversight function “must be more rigorously exercised.” That, according to the opinion, “entails a sensitivity to compliance issues intrinsically critical to the company.”

Marchand held the board had not made a “good faith effort to put in place a reasonable system of monitoring and reporting” when it left compliance with food safety mandates to management’s discretion, rather than implementing and then overseeing a more structured compliance system. The Court considered the absence of various board-level structures “before the listeria outbreak engulfed the company.” The Court concluded that the complaint fairly alleged several dispositive deficiencies, such as the absence of a board committee that addressed food safety and the absence of a regular process or protocols that required management to keep the board apprised of food safety compliance practices, risks, or reports existed.

The Court concluded that Plaintiffs had carried their pleading burden that the Boeing directors had utterly failed to implement any reporting or information system or controls. According to the Court, like food safety in Marchand, airplane safety “was essential and mission critical” to Boeing’s business, and externally regulated. To support its conclusion, the Court looked to several facts such as:

  • The Boeing Board had no committee charged with direct responsibility to monitor airplane safety.
  • The Board did not monitor, discuss, or address airplane safety on a regular basis.
  • The Board had no regular process or protocols requiring management to apprise the Board of airplane safety; instead, the Board only received ad hoc management reports that conveyed only favorable or strategic information.
  • Management saw red, or at least yellow, flags, but that information never reached the Board.

In addition to the inferences drawn above, the Court found the pleading-stage record supported an explicit finding of scienter.  Here the Court looked to internal emails amongst Board members stating things like “we should devote the entire board meeting (other than required committee meetings and reports) to a review of quality within Boeing,” The Court also noted that the Board knowingly fell short was also evident in the Board’s public crowing about taking specific actions to monitor safety that it had not actually performed.

Yatra Online, Inc., v. Ebix, Inc. concerned an abandoned merger that Plaintiff, Yatra Online Inc. (“Yatra”), asserts was sabotaged post-signing by Defendants, Ebix, Inc. and EbixCash Travels, Inc. after Ebix determined the deal was no longer attractive.

Delays were encountered as an S-4 was awaiting SEC clearance and Ebix sought to renegotiate certain matters.  Fed up with Ebix’s behavior during the extended renegotiations, and after the final outside closing date lapsed, Yatra terminated the Merger Agreement and filed a lawsuit against Ebix.  The complaint included an action for breach of the Merger Agreement amongst other things.

The relevant provision of the merger agreement read as follows:

“In the event of any termination of this Agreement as provided in Section 8.1, the obligations of the parties shall terminate and there shall be no liability on the part of any party with respect thereto, except for the confidentiality provisions of Section 6.4 (Access to Information) and the provisions of Section 3.26 (No Other Representations and Warranties; Disclaimers), Section 4.17 (No Expenses), this Section 8.2, Section 8.3 (Termination Fees) and Article IX (General Provisions), each of which shall survive the termination of this Agreement and remain in full force and effect; provided, however, that, subject to Section 8.3(a)(iii), nothing contained herein shall relieve any party from liability for damages arising out of any fraud occurring prior to such termination, in which case the aggrieved party shall be entitled to all rights and remedies available at law or equity. The parties acknowledge and agree that nothing in this Section 8.2 shall be deemed to affect their right to specific performance under Section 9.9 prior to the valid termination of this Agreement. In addition, the parties agree that the terms of the Confidentiality Agreement shall survive any termination of this Agreement pursuant to Section 8.1 in accordance with its terms.”

Ebix argued that Yatra’s decision to terminate the Merger Agreement barred its claims for breach of contract.  Yatra responded that the phrase “with respect thereto” can reasonably be read to modify “any termination of this Agreement” (as opposed to “obligations”). Under this construction, the provision cannot be understood to eliminate damages owed for prior breaches of “obligations,” but only damages caused by the act of terminating the Merger Agreement.

The Court found Yatra’s reading of the provision stretched the words beyond their tolerance. The comma following “Section 8.1” breaks the sentence, reading naturally to indicate the Merger Agreement’s drafters intended the phrase “with respect thereto” to modify “the obligations of the parties” as opposed to “any termination of this agreement.”

Yatra’s position—that the provision only extinguished liability arising from “any termination of this Agreement”—was inconsistent with the language immediately following “with respect thereto,” which “except[s]” certain obligations under the Merger Agreement, as specifically enumerated, from the effects of the contractual limitation of liability. That clause would be superfluous if the effect of the provision was to limit liability only arising from the act of terminating the Merger Agreement.

Moreover, contrary to Yatra’s contention that termination leaves claims for breach of contract based on prior acts unaffected, the Court noted Section 8.2 expressly carved out only liability for “fraud occurring prior to such termination,” implying that liability for all other claims (including contract based claims) for acts “occurring prior” to termination did not survive post-termination.

The Court also considered the precedent set by AB Stable VIII LLC v. Maps Hotels & Resorts One LLC. The court in AB Stable expressly observed that “[u]nder the common law, termination results in an agreement becoming void, but that fact alone does not eliminate liability for a prior breach.” The court went on to explain that when parties include a provision stating that “there shall be no liability on the part of either party” upon termination, they “alter[] the common law rule” and “broadly waive[] contractual liability and all contractual remedies.”

The Court rejected Yatra’s argument that the result was absurd.  By Yatra’s own admission, its obligations under the Merger Agreement “ceased, because Ebix materially breached the Merger Agreement.” Thus, the Merger Agreement provided a choice to a party faced with a breach by the counterparty: either (a) sue for damages (or specific performance) or (b) terminate the Merger Agreement and extinguish liability for all claims arising from the contract (except those specifically carved-out, including claims for fraud). According to the Court, the latter option would be preferable where the terminating party believed it had some liability exposure of its own and would prefer to terminate the Merger Agreement to eliminate that risk. This is a perfectly logical way for parties contractually to manage risk, and the Court should not to redline the parties’ bargained-for limitations of liability because one party now regrets the deal it struck.

Stockholders of Zimmer Biomet Holdings, Inc., brought a derivative law suit.  Zimmer is a company that manufactures and markets various products in the highly regulated medical device industry. The plaintiffs’ claims stemmed from a September 12, 2016 “for cause” inspection of Zimmer’s North Campus site in Warsaw, Indiana by the U.S. Food & Drug Administration. The compliance problems identified during that inspection resulted in Zimmer issuing a blanket hold on shipments of products processed at the North Campus facility. Zimmer subsequently reported disappointing financial results for the third quarter of 2016, reduced its fourth quarter guidance, and saw its stock price fall 14%.

As with many derivative actions, a threshold issue was whether the plaintiffs’ failure to make a pre-suit demand on the Zimmer board was excused. Of the eleven-member board in place when this lawsuit was filed, the plaintiffs acknowledge that eight directors were independent. However, plaintiffs argued that making a demand would nonetheless have been futile because a majority of those directors face a substantial likelihood of liability.

However, the plaintiffs did not allege particularized facts to support that argument that directors faced a substantial likelihood of liability. Zimmer had an exculpation provision in its charter, meaning that the plaintiffs were required to plead facts suggesting a fair inference that the directors breached their duty of loyalty.

According to the Court, the only challenged disclosure that came close to directly implicating any of the Board members is the third quarter earnings release that was reviewed and approved by the Audit Committee.

On October 24, 2016, the Audit Committee—along with Zimmer’s officers, its counsel, and its external auditor—met to review the Company’s draft earnings release for the third quarter of 2016 and were given an “update on the ongoing FDA inspection” of the North Campus. After discussion, the Audit Committee members “expressed no objections” to the contents of the draft release.

Citing well accepted law, the Court noted that whenever directors communicate publicly or directly with shareholders about the corporation’s affairs, with or without a request for shareholder action, directors have a fiduciary duty to shareholders to exercise due care, good faith and loyalty.”  The duty of disclosure “is not an independent duty, but derives from the duties of care and loyalty.” The contours of that duty and what it requires of fiduciaries are context specific. Where (like here) the disclosures at issue did not concern a request for stockholder action, Malone v. Brincat requires that a plaintiff demonstrate scienter—i.e., that the directors “deliberately misinform[ed] shareholders about the business of the corporation, either directly or by a public statement.” Because Zimmer’s certificate of incorporation included an exculpatory provision under Section 102(b)(7), the plaintiffs “must plead particularized factual allegations that ‘support the inference that the disclosure violation was made in bad faith, knowingly or intentionally’” to establish demand futility.

According to the Court, Delaware courts may infer scienter for Malone claims where certain types of specific factual allegations are made. A plaintiff must plead with particularly that directors “had knowledge that any disclosures or omissions were false or misleading or . . . acted in bad faith in not adequately informing themselves.” A plaintiff also must allege “sufficient board involvement in the preparation of the disclosures” to “connect the board to the challenged statements.”

The third quarter earnings release covered the period ending September 30, 2016—just one day after the first ship hold went into effect. It was uncertain how much, if at all, the ship hold affected Zimmer’s third quarter results (or what the Audit Committee knew about potential effects). But based on the Complaint, there was reason to infer that the Audit Committee members knew that the FDA inspection of the North Campus would have an effect on Zimmer’s revenue guidance when they approved the earnings release. As the Complaint points out, the Audit Committee was given an update “on the ongoing FDA inspection of [North] Campus” during its October 24, 2016 meeting. “At the conclusion of [that] discussion, the Committee members expressed no objections to the contents of the draft earnings release.”

The plaintiffs argued that the earning release was an attempt to “hide and obscure” information from the public because the release “contained no disclosure of the FDA inspection or manufacturing shutdown.” In other words, plaintiffs argued the Audit Committee did not ensure that Zimmer adequately disclosed a potential reason for its reduced guidance. According to the Court, that assertion might call into question the Audit Committee members’ “‘erroneous judgment’ concerning the proper scope and content of the disclosure.” But that would, at best, support an exculpated claim for breach of the directors’ duty of care according to the Court. An inference cannot be drawn, from the limited allegations in the Complaint, that the Audit Committee approved an earnings release reducing revenue guidance while intentionally omitting material information about a possible underlying cause. The plaintiffs did not ascribe any bad faith actions or motives to the Audit Committee members that would demonstrate otherwise.

The SEC announced a settled enforcement action against Healthcare Services Group, Inc., John C. Shea, CPA, and Derya D. Warner regarding failure to make accruals for outstanding litigation.

According to the SEC’s order:

  • Under ASC 450-20-25-2, a loss contingency shall be accrued if (a) it is probable that an asset had been impaired or a liability had been incurred at the date of the financial statements, and (b) the amount of loss can be reasonably estimated. A loss or liability is considered probable if it is likely to occur. ASC 450-20-20.
  • By Q1 2014, HCSG had determined to seek an out-of-court settlement of the three pending class-action lawsuits in California state court (collectively, the “Irizarry” cases) after a joint mediation of those cases with plaintiffs. Under the proposed settlement, HCSG agreed to pay between $2.5 million and $3 million to plaintiffs, with the final amount to be determined based on the amount of claims submitted by class members. These and other settlement terms were set forth in a proposed settlement agreement that was submitted to the court for preliminary approval in Q1 2014. Shea, HCGS’ CFO, had participated in the mediation along with lawyers on behalf of HCSG. At all times, Shea was aware of the proposed settlement amount and the submission of the settlement agreement to the court for preliminary approval.
  • HCSG, however, did not accrue for the loss contingency related to the settlement of the Irizarry cases even though the loss was both probable and reasonably estimable no later than Q1 2014. Based on the information available at the time, Shea was aware that, like the other California employment class actions that HCSG had settled in 2013, HCSG intended to settle the Irizarry cases instead of continuing to litigate them. Shea also knew that HCSG would likely incur a liability between $2.5 million and $3 million under the out-of-court settlement, depending on the amount of claims submitted by class members. Shea determined that no amount for this loss contingency was probable or reasonably estimable because the Irizarry settlement claims process was not complete, and the settlement had not received final court approval at the time. Shea also did not maintain any documentation of any purported analysis under ASC 450 of a litigation loss contingency.
  • HCSG also did not disclose the nature of this loss contingency or an estimate of the amount of loss in its Q1 2014 Form 10-Q. The Form 10-Q stated HCSG was “subject to various claims and legal actions[,]” including “payroll and employee-related matters[.]” It also stated HCSG “provide[s] accruals if the exposures [to claims and legal actions] are probable and estimable,” and “[i]f an adverse outcome of such claims and legal actions is reasonably possible, we assess materiality and provide such financial disclosure, as appropriate.” Notwithstanding these statements, which were repeated in other Forms 10-Q and 10-K from 2014 to 2015, HCSG did not disclose the nature or an estimate of the loss contingency for the settlement of the Irizarry cases under ASC 450.
  • No accrual was made in Q2 2014 even though the Court had granted preliminary approval of the settlement.
  • HCSG accrued $2.5 million for the settlement of the Irizarry cases in Q3 2014. This amount was based, in part, on the number of claims submitted under the settlement agreement – an amount which the SEC stated was probable and reasonably estimable no later than Q1 2014.
  • The SEC made similar allegations with respect to an out-of-court settlement of a collective action brought against it in 2013 captioned, Kelly v. Healthcare Services Group, Inc.

Among other things, HCSG agreed to pay a $6,000,000 civil monetary penalty to the SEC to resolve the matter.

The defendants (respondents) did not admit or deny the facts set forth in the SEC order.

The NYSE recently amended its related party transaction rules to align with Regulation S-K Item 404.  The one key difference from Regulation S-K was that the NYSE did not apply the $120,000 transaction threshold which qualifies Regulation S-K.  Therefore, theoretically, a $1 transaction could trip the NYSE rule, although that was unlikely because it would be doubtful a related party would have a material interest in a $1 transaction as required by Regulation S-K.

Having seen the error it its ways, the NYSE has now modified it related party rules to include the $120,000 transaction threshold.

The rule change is effective upon filing, subject to SEC review.

In its rule filing the NYSE noted that in the period since the adoption of the previous amendment, it became clear to the Exchange that the amended rule’s exclusion of the applicable transaction value and materiality thresholds was inconsistent with the historical practice of many listed companies, and had unintended consequences. The Exchange learned that many listed companies  had a longstanding understanding that they were required to subject related party transactions to the review process required by the NYSE’s rules only if such transactions exceeded any applicable transaction value or materiality thresholds in the applicable SEC rules and therefore were required to be disclosed. This approach is embodied in the written related party transaction policies of many listed companies and is typically a part of the annual questionnaire completed by directors and officers in connection with the company’s annual meeting. By not permitting the use of transaction value and materiality thresholds, the previous amendment had the unintended effect of disrupting the normal course transactions of listed companies. Because of the previous amendment, many companies have been required to adopt for the first time two separate standards for related party transactions — one for disclosure and another for review and approval of transactions. This has created a significant compliance burden for issuers with respect to small transactions that are considered immaterial for purposes of other regulatory requirements. Furthermore, the Exchange believes that the review and approval of large numbers of immaterial transactions is not an effective use of the time of independent directors who have many other time-consuming oversight obligations with respect to matters that are higher risk and more material to the company.

Suzanne Flannery v. Genomic Health, Inc. et al is a case about the acquisition of Genomic Health, Inc. (“Genomic” or the “Company”) by Exact Sciences Corp. (“Exact”) pursuant to a Merger Agreement.

Count I of the inevitable complaint asserted the Baker Brothers Entities, which were purportedly the controlling stockholders of Genomic, along with Exact and Genomic, violated Section 203 of the Delaware General Corporation Law because the Baker Brothers Entities separately agreed to sell their greater than 15% stake in Genomic to Exact prior to the Merger.  More specifically, Plaintiff contended that Defendants violated Section 203 because Exact entered into a business combination with Genomic two days after Exact became an interested stockholder.

Plaintiff claimed Exact became an interested stockholder of Genomic on July 26, two days prior to the Board signing the Merger Agreement, when the Baker Brothers Entities allegedly agreed to vote their shares in favor of the transaction.

Defendants disagreed and argued Plaintiff’s Section 203 claim failed for among other things, the following reasons:

  • Exact never became an “Interested Stockholder” because the Baker Brothers Entities did not agree with Exact to vote in favor of the Merger until after the Board approved the Merger (when the Voting Agreement was actually executed), and
  • the Board implicitly approved the Voting Agreement prior to July 26, the date Plaintiff claims the two sides came to an agreement.

Plaintiff pointed to the Proxy, which stated that on July 26 “representatives of Akin Gump contacted representatives of Skadden to inform them that the Baker Brothers Entities were no longer willing to agree to transfer restrictions on their shares between signing and closing, but would still agree to vote in favor of the transaction.” This, according to Plaintiff, evidenced an “agreement, arrangement or understanding for the purpose of acquiring . . . such stock,” in violation of Section 203.

According to the Court, the Proxy’s language did not evidence either a formal or informal meeting of the minds between the Baker Brothers Entities and Exact on prior to approval of the Merger on July 26. In fact, the Proxy disclosed that the Baker Brothers Entities had plainly rejected Exact’s proposed voting agreement and that they would only agree to a voting agreement with different terms.

The fact that that the Baker Brothers eventually expressed their intent to support the Merger did not change the analysis. Without an agreement, Exact cannot conceivably be classified as an Interested Stockholder and thus cannot have violated Section 203. This was further bolstered by the existence of the later-executed Voting Agreement, entered into immediately after the Board approved and executed the Merger Agreement. That agreement evidenced nothing more than the commonplace scenario where a large stockholder agreed to vote its shares in favor of a transaction approved and authorized by the board of the target company.

As to implicit approval, the Court noted the only reasonable inference was that the Board well understood Exact would require voting agreements in connection with the Merger.  By continuing to negotiate with Exact on those terms, the Board demonstrated its agreement to the unremarkable proposition that Exact would seek to secure the commitment of Genomic’s largest stockholder to the Merger prior to the stockholder vote. That agreement to the transaction which resulted in Exact becoming an Interested Stockholder,” prior to the parties themselves agreeing, excepted the transaction from Section 203’s proscriptions.

Ultimately, the Court found Plaintiff’s attempt to pigeonhole Defendants’ conduct into a violation of Section 203 was inconsistent with the statute’s designated purpose. According to the Court, Section 203 was intended “to strike a balance between the benefits of an unfettered market for corporate shares and the well-documented and judicially recognized need to limit abusive takeover tactics.”

The Court stated Plaintiff’s view of Section 203 would authorize the court to prevent a merger even when a target’s board was aware of, and did not object to, a buyer’s attempt to secure the endorsement of a significant stockholder in favor of a deal that the board itself was attempting to secure for all of the target’s stockholders. Even if Plaintiff was correct that the Board had not formally approved of either the Merger or Voting Agreement prior to July 26, and that there was a meeting of the minds between the Baker Brothers Entities and Exact with respect to voting on July 26, it was undeniable that the Merger was formally approved by the Board on July 28 (with full knowledge of the Voting Agreement negotiations) and endorsed by the Board much earlier than that.  Nothing about this dynamic suggested Exact was engaged in “abusive takeover tactics.” The Court noted that it should be hesitant to strain the statute’s language to cover situations that do not threaten the interests the statute was designed to protect. Therefore, Plaintiff’s Section 203 was dismissed.

Online Healthnow, Inc. et al v. CIP OCL Investments, LLC et al considers whether certain indemnification limits violate the public policy of the State of Delaware.

The opinion begins with the following passages:

In a scene from the classic film Butch Cassidy and the Sundance Kid, the scofflaw protagonists are frustrated in their attempts to gain entry into a cash-filled train car as they attempt to rob it. In his frustration, Butch resorts to a heavy dose of dynamite, apparently too heavy. On detonation, the entire train car, and its contents, are blown to bits. As the ash from incinerated currency rains down, Sundance turns to Butch and asks sarcastically, “Think you used enough dynamite there, Butch?”

The issue addressed in this opinion is whether, in the context of an acquisition agreement, Delaware courts should enforce broad contractual limitations on the right of contracting parties to bring post-closing claims that are so potent they effectively eviscerate all claims, including those that allege the contract itself is an instrument of fraud. In other words, can parties to a contract, by their agreement, detonate all bona fide contractual fraud claims (discovered or undiscovered) with the stroke of their pens at the closing table . . .

For reasons explained below, Defendants’ motion to dismiss must be denied. Under Delaware law, a party cannot invoke provisions of a contract it knew to be an instrument of fraud as a means to avoid a claim grounded in that very same contractual fraud. Stated more vividly, while contractual limitations on liability are effective when used in measured doses, the Court cannot sit idly by at the pleading stage while a party alleged to have lied in a contract uses that same contract to detonate the counter-party’s contractual fraud claim. That’s too much dynamite.

The case involved an acquisition.  Seller and its affiliates apparently discovered during the course of the auction that target’s computer systems did not properly account for state sales taxes due for sales.  Seller and its affiliates did not advise the ultimate buyer of this fact and buyer alleged the representation in the Stock Purchase Agreement were made with knowing falsity on behalf of the Seller and the other Defendants.

Defendants contended that the survival clause expressly provided that the representations and warranties terminated upon closing, and therefore any claim (including a fraud claim) arising from those reps and warranties was extinguished when the deal closed. Second, Defendants contend even if the Court found the limitations clause did not bar Plaintiffs’ fraud claim altogether, the SPA’s anti-reliance and non-recourse provisions work together to bar Plaintiffs’ fraud claim.

The Court ultimately held that based on the weight of authority, and Delaware’s public policy, the SPA’s survival clause cannot, and does not, defeat Plaintiffs’ contractual fraud claims. The Court noted that the clause served its purpose—there can be no post-closing claim for breach of a warranty that did not survive closing. But the Sellers cannot invoke a clause in a contract allegedly procured by fraud to eviscerate a claim that the contract itself is an instrument of fraud.

Defendants also contended that CIP Capital, which controlled the Seller, and the other Defendants could not be held liable for Seller’s contractual representations under the SPA’s non-recourse and anti-reliance clauses. Plaintiffs responded that it expressly relied on the allegedly fraudulent misrepresentations made by Seller, and the Seminal Delaware case ABRY Partners does not permit CIP Capital to take cover behind a non-recourse provision if it knowingly participated in the alleged contractual fraud.

The Court followed the holding in ABRY Partners which noted “that the public policy of this State will not permit the Seller to insulate itself from [liability or] the possibility that the sale would be rescinded if the Buyer can show . . . that the Seller knew that the Company’s contractual representations and warranties were false.” Because Plaintiff had well pled that CIP Capital did, in fact, know of and facilitate the fraudulent misrepresentations in the SPA through its participation in the sale, the Court held CIP Capital cannot invoke the non-recourse provision to avoid liability under ABRY Partners and its progeny.

Often in M&A transactions one stumbles across conversions to and from LLCs that do not strictly adhere with statutory formalities or terms of related limited liability company agreements.  The Delaware Court of Chancery considered the validity of a conversion of a Delaware LLC to a Puerto Rico LLC in In re Coinmint, LLC which was effected without technical compliance with the Delaware LLC Act and the related Operating Agreement.

As background, the Court found Prieur Leary controlled 18.5% of Coinmint through Mintvest Capital Ltd.   Ashton Soniat controlled the balance of Coinmint through Coinmint Living Trust, or CLT.

On or about January 19, 2018, the Company filed a Certificate of Conversion with the Delaware Secretary of State and the Secretary of State. On January 25, Coinmint domesticated in Puerto Rico. As of that date, Coinmint became and was thereafter operated as a Puerto Rican entity. Mintvest contested the Conversion, claiming that Leary was unaware of the Conversion until September 2019 and that the Conversion was invalid because Leary never authorized it on Mintvest’s behalf.

The Court advised that actions that do not comport with an operating agreement’s terms may be void or voidable. Void acts are those the entity itself has no implicit or explicit authority to undertake or those acts that are fundamentally contrary to public policy. Stated differently, they are acts that the entity lacks the power or capacity to effectuate. Voidable acts are within the power or capacity of an entity, but were not properly authorized or effectuated by the representatives of the entity. The Court also advised that drafters of operating agreements are also free to use their flexibility in contracting to agree that failure to follow certain procedures means an otherwise voidable action is void.

Summarizing, the Court stated where:

  • the Delaware Limited Liability Company Act enables the entity or its representatives to take certain action as distilled in the operating agreement;
  • the operating agreement implements that grant of authority and prescribes certain approvals for effectuating it; and
  • the operating agreement does not expressly deem the action void for failure to obtain those approvals,

that action will be “voidable, not void,” as the entity and its representatives could have carried out the action had “the proper approvals had been obtained.” Such voidable breaches of LLC agreements are subject to equitable defenses, including waiver, estoppel, and laches.

Coinmint’s Operating Agreement did not specify the manner of authorizing a conversion.  Therefore the Court reviewed the Delaware Limited Liability Company Act. Section 18-216 of the Act governs conversion of a Delaware limited liability company. Section 18-216(b) supplies a default rule that is subject to contractual variation, not a mandatory rule.  It provides that if the limited liability company agreement does not specify the manner of authorizing a conversion of the limited liability company and does not prohibit a conversion of the limited liability company, the conversion shall be authorized in the same manner as is specified in the limited liability company agreement for authorizing a merger or consolidation that involves the limited liability company as a constituent party to the merger or consolidation.

The Operating Agreement’s relevant terms required two steps to effect a merger:

  • majority Member consent under Section 4.6,
  • followed by formal Board approval via meeting or written consent, under Sections 4.3(f) and 4.4.

It was undisputed that the Managers did not approve the Conversion at a board meeting or secure written consents. But in view of CLT’s majority stake and the interplay of Sections 4.3(f), 4.4, and 4.6, that failure rendered the Conversion voidable under the Operating Agreement, rather than void.

Section 4.6 of the Operating Agreement conditioned the Board’s power to effectuate a conversion on the consent of a “Majority of Members” who “in the aggregate, own more than fifty percent (50%) of the Sharing Ratios owned by all of the Members.”  That provision provided:

Notwithstanding anything to the contrary contained in this Agreement, without the consent of Majority of Members, neither the Board nor any Manager or Officer shall have the power or authority . . . . [t]o effect a merger or plan of exchange of the Company . . . .

Failure to obtain that majority consent would strip the Board and any Manager of its power to effectuate a merger, or, in this case, the Conversion. If a conversion were completed without the consent of the Majority of Members, then it would be void ab initio, not voidable.

But in other parts of the opinion the Court found Mintvest was diluted to 18.2%, and CLT held 81.8%. CLT alone “own[ed] more than fifty percent (50%) of the Sharing Ratios owned by all of the Members.” So CLT alone could give consent of the “Majority of Members” and did so. As a result, the Board retained the power to authorize the Conversion.

With majority Member consent, conversion must then follow Section 4.4 of the Operating Agreement, which provides that “all actions of the Board provided for here in shall be taken either at a meeting and evidenced by written minutes thereof . . . or by written consent without a meeting.”

If a conversion is challenged because the Board did not formally authorize it under Sections 4.3(f) and 4.4, that failure is voidable and subject to equitable defenses. CLT and Mintvest’s failure to comply with Section 4.3 and 4.4’s formalities on Coinmint’s behalf is ratifiable because the Company could lawfully accomplish it “if it d[id] so in the appropriate manner.”

The Court held Mintvest’s challenge to the Conversion as improperly authorized under Sections 4.3(f) and 4.4 was barred by the equitable defenses.  The record showed Leary was intimately involved in pursuing redomestication in Puerto Rico and invoked that decision in several Company initiatives.  Nothing in the record indicated that Leary objected to the Conversion as it was taking place or after.  The record reflected that Leary participated in the Conversion and did not object to it on Mintvest’s behalf until filing the action in the Delaware Court of Chancery. Because Leary  confirmed the Conversion on multiple occasions he therefore waived the Operating Agreement’s Board vote and consent requirements.

ISS has opened its annual benchmark policy survey.  The survey usually foreshadows upcoming changes to its policies.

Areas addressed in this year’s survey include:

  • Should non-financial Environmental, Social, and/or Governance-related metrics be incorporated into executive compensation programs?
  • Opinions regarding third-party racial equity audits.
  • Detrimental and/or problematic practices for virtual only shareholder meetings.
  • Should ISS’ pay-for-performance screen include a longer-term perspective (for example, a three-year assessment) of CEO pay quantum beyond the one-year horizon currently utilized in the ISS pay-for-performance quantitative screen?
  • Views on mid-cycle changes to long-term incentive programs for companies incurring long-term negative impacts.
  • For companies with poor governance structures that were previously grandfathered, should ISS revisit these problematic provisions and consider issuing adverse voting recommendations in the future where they still exist?
  • If a company has sought shareholder approval to eliminate supermajority vote requirements, but the management proposal failed to receive the requisite level of shareholder support needed for approval, should ISS continue to make recurring adverse director vote recommendations for maintaining the supermajority vote requirements?
  • Does it make sense for investors to generally vote in favor of SPAC transactions, irrespective of the merits of the target company combination or any governance concerns?

In tandem, ISS is launching a separate Climate Survey for feedback relevant to both ISS’ benchmark and specialty climate policy evolvement, in order to determine views on minimum criteria for boards in overseeing climate-related risks, plus market sentiment on shareholders having the right to regularly vote on a company’s climate transition plans.

Both surveys are slated to close on August 20, 2021.

The SEC has approved the Nasdaq board diversity rules.

Diverse Board Representation

In general, each Nasdaq listed company must have, or explain why it does not have, at least two members of its board of directors who are Diverse, including (i) at least one Diverse director who self-identifies as Female; and (ii) at least one Diverse director who self-identifies as an Underrepresented Minority or LGBTQ+.

Diverse is defined to mean an individual who self-identifies in one or more of the following categories: Female, Underrepresented Minority, or LGBTQ+.

Female is defined to mean an individual who self-identifies her gender as a woman, without regard to the individual’s designated sex at birth.

Underrepresented minority is defined to mean an individual who self-identifies as one or more of the following: Black or African American, Hispanic or Latinx, Asian, Native American or Alaska Native, Native Hawaiian or Pacific Islander, or Two or More Races or Ethnicities.

LGBTQ+ means an individual who self-identifies as any of the following: lesbian, gay, bisexual, transgender, or as a member of the queer community.

Amongst other things, the rules provide accommodations for:

  • A smaller reporting company must have, or explain why it does not have, at least two members of its board of directors who are Diverse, including at least one Diverse director who self identifies as Female. The second Diverse director may include an individual who self-identifies as one or more of the following: Female, LGBTQ+, or an Underrepresented Minority.
  • Each company with a board of directors of five or fewer members must have, or explain why it does not have, at least one member of its board of directors who is Diverse. If a Company has five members on its board of directors before becoming subject to the new rules, it shall not become subject to the requirement to have at least two members of its board of directors who are Diverse if it adds one director to satisfy this this rule for five or fewer board members, thereby becoming a six-member board. However, a company would become subject to the new rules if it subsequently expands its board.
  • Certain modifications are made for foreign private issuers.
  • The following types of companies are exempt: acquisition companies; asset-backed issuers and other passive issuers; cooperatives; management investment companies; and issuers of nonvoting preferred securities, debt securities and derivative securities.

If a company satisfies the requirements of the rule by explaining why it does not meet the applicable diversity objectives of the rule, the company must: (i) specify the requirements of the rule that are applicable; and (ii) explain the reasons why it does not have two Diverse directors (or one Diverse director where permitted). Such disclosure must be provided: (i) in advance of the company’s next annual meeting of shareholders in any proxy statement or any information statement (or if none, Form 10-K etc.) or on the Company’s website. If the Company provides such disclosure on its website, then the Company must also notify Nasdaq regarding the disclosure.  Nasdaq will not evaluate the substance or merits of the response.

Each Company listed on The Nasdaq Global Select Market, The Nasdaq Global Market, and The Nasdaq Capital Market (including a Company with a permitted smaller board) must have, or explain why it does not have, at least one Diverse director by the later of:

  • two calendar years after August 6, 2021 (the “First Effective Date”); or
  • the date the Company files its proxy statement or its information statement (or, if the Company does not file a proxy, in its Form 10-K etc) for the Company’s annual shareholders meeting during the calendar year of the First Effective Date.

Each Company listed on The Nasdaq Global Select Market or The Nasdaq Global Market must have, or explain why it does not have, at least two Diverse directors by the later of:

  • four calendar years after August 6, 2021 (the “Second NGS/NGM Effective Date”); or
  • the date the Company files its proxy statement or its information statement (or, if the Company does not file a proxy, in its Form 10-K or 20-F) for the Company’s annual shareholders meeting during the calendar year of the Second NGS/NGM Effective Date.

Each Company listed on The Nasdaq Capital Market must have, or explain why it does not have, at least two Diverse directors by the later of:

  • five calendar years after August 6, 2021 (the “Second NCM Effective Date”) or
  • the date the Company files its proxy statement or its information statement (or, if the Company does not file a proxy, in its Form 10-K etc.) for the Company’s annual shareholders meeting during the calendar year of the Second NCM Effective Date.

Board Diversity Disclosure

In addition, each Nasdaq listed company must annually disclose, to the extent permitted by applicable law, information on each director’s voluntary self-identified characteristics in a prescribed format referred to as the Board Diversity Matrix. Following the first year of disclosure, all companies must disclose the current year and immediately prior year diversity statistics using the Board Diversity Matrix.

In the proposed Board Diversity Matrix, a company would be required to provide the total number of directors on its board, and the company (other than a Foreign Issuer) would be required to provide the following:

  • the number of directors based on gender identity (female, male, or non-binary) and the number of directors who did not disclose gender;
  • the number of directors based on race and ethnicity (African American or Black, Alaskan Native or Native American, Asian, Hispanic or Latinx, Native Hawaiian or Pacific Islander, White, or Two or More Races or Ethnicities), disaggregated by gender identity (or did not disclose gender);
  • the number of directors who self-identify as LGBTQ+; and
  • the number of directors who did not disclose a demographic background under the second and third bullet points above.

The Board Diversity Matrix must be provided in any proxy statement or any information statement (or if none, Form 10-K etc.) or on the Company’s website.  Companies exempt from the board diversity rules do not need to comply with these disclosures.

This disclosure rule is operative one year after August 6, 2021 (the “Effective Date”). A Company must be in compliance with this rule by the later of:

  • one calendar year from the Effective Date;
  • the date the Company files its proxy statement or its information statement for its annual meeting of shareholders (or, if the Company does not file a proxy or information statement, the date it files its Form 10-K or 20-F) during the calendar year of the Effective Date.