Delaware Law Watch

On February 17, 2025, the Delaware General Assembly introduced a proposed bill (SB 21) to amend Sections 144 and 220 of Delaware General Corporation Law; both are described below.

Section 144 (Interested directors). If passed, the amendment will provide safe harbor procedures for transactions involving interested directors/officers, a control group, or a controlling stockholder. Specifically, the proposed amendment:

1. Provides that a transaction with an interested director or officer would be protected if (1) approved by the votes of a majority of the disinterested directors (even if less than a quorum), or (2) approved or ratified by a majority of the votes cast by the disinterested stockholders entitled to vote thereon.

2. Provides that a controlling stockholder transaction that is not a “going private transaction” may be entitled to the statutory safe harbor protection if it is approved or recommended, as applicable, (1) by a committee consisting of a majority of disinterested directors, or (2) by a majority of the votes cast by the disinterested stockholders and the transaction was conditioned on a vote of the disinterested stockholders at or prior to the time it is submitted to stockholders for their approval or ratification.  But a controlling stockholder transaction that constitutes a “going private transaction” would be protected only it satisfied both requirements under (1) and (2) described in the preceding sentence. 

3. Defines a control group as “2 or more persons that are not controlling stockholders that, by virtue of an agreement, arrangement, or understanding between or among such persons, constitute a controlling stockholder.” And a controlling stockholder would be defined as “any person that, together with such person’s affiliates and associates a. Owns or controls a majority in voting power of the outstanding stock of the corporation entitled to vote generally in the election of directors; or b. Has the power functionally equivalent to that of a stockholder that owns or controls a majority in voting power of the outstanding stock of the corporation entitled to vote generally in the election of directors by virtue of ownership or control of at least one-third in voting power of the outstanding stock of the corporation entitled to vote generally in the election of directors or for the election of directors who have a majority in voting power of the votes of all directors on the board of directors and power to exercise managerial authority over the business and affairs of the corporation.”

4. Provides that controlling stockholders and control groups, in their capacity as such, cannot be liable for monetary damages for breach of the duty of care. 

5. Sets forth criteria for determining the independence and disinterestedness of directors and stockholders; among other things, a director of a corporation that is listed on a national securities exchange is “presumed to be a disinterested director with respect to an act or transaction to which such director is not a party” if the director satisfies the exchange’s criteria for director independence. 

Section 220 (Inspection of books and records). If passed, the amendment may narrow stockholders’ rights to inspection by specifying what constitutes books and records. Specifically, the proposed amendment:

1. Defines the “books and records” that a stockholder may inspect pursuant to a demand, including a corporation’s organizational documents, minutes from board and committee meetings, and materials provided to directors in connection with such meetings.

2. Sets forth certain conditions that a stockholder must satisfy in order to make an inspection of books and records, including a requirement that the documents sought must be “specifically related” to the stockholder’s proper purpose.

3. Provides that documents from a Section 220 production will be deemed to be incorporated by reference into any complaint filed by or at the direction of a stockholder on the basis of information obtained through a demand for books and records.

4. Provides that if the corporation does not have specified books and records, including minutes of board and committee meetings, actions of board or any committee, financial statements and director and officer independence questionnaires, the Court of Chancery may order the production of additional corporate records necessary and essential for the stockholder’s proper purpose.

We will keep you updated as these matters advance through the legislature.

For more information regarding any of the material provided herein, or if you have any questions (or suggested source material for future updates) relating to private M&A under Delaware law, please reach out to the Private Company Delaware Law Committee or its members Jim Matarese, Mike Kendall, Jennifer Chunias, Joe Rockers, Jordan Weiss, Christina Ademola, Dylan Schweers, Trey O’Callaghan, S. Toni Wormald, and Connor Hannagan.

Background
On November 15, 2024, the Court of Chancery issued a post-trial opinion in GB-SP Holdings, LLC v. Walker, which considered whether certain directors of Bridge Street Worldwide, Inc. (“BSW”) breached their fiduciary duties by entering into a forbearance agreement with BSW’s creditor, Domus BWW Funding LLC (“Domus”), a subsidiary of Versa Capital Management, LLC (“Versa”).

BSW was in default under its senior secured debt when Domus attempted to gain control and economic ownership of BSW by purchasing such senior secured debt from BSW’s existing creditors. Following this acquisition and after BSW continued to default on such debt, BSW and Domus entered into a forbearance agreement, pursuant to which BSW provided Domus first-priority security interests in additional collateral in exchange for additional first-lien loans to cover past-due interest and working capital needs.

While negotiating the forbearance agreement, BSW’s board blocked its largest stockholder’s (the “Major Stockholder”) information rights and right to appoint a board designee. Domus (with knowledge of these facts) (i) agreed to indemnify the existing directors (the “Pre-Forbearance Directors”) for any claims asserted or supported by the Major Stockholder, and (ii) entered into MOUs with BSW’s management (including two Pre-Forbearance Directors) for continued employment and bonuses from Domus.

After the forbearance agreement became effective, five new directors were elected to join BSW’s board (the “Post-Forbearance Directors”), four of whom required the approval of Domus and the fifth of whom was the Major Stockholder’s designee. When BSW breached the forbearance agreement, the Post-Forbearance Directors approved the foreclosure on collateral by Domus, and BSW transferred the equity of its operating subsidiaries to Domus in exchange for Domus cancelling the majority of BSW’s senior secured debt. 

Following foreclosure, the Major Stockholder asserted a variety of claims against the Pre-Forbearance Directors, the other Post-Forbearance Directors, Versa, Domus, and BSW, claiming, among other things, that the BSW’s directors breached their duty of loyalty in approving the forbearance agreement and the foreclosure, and further that Versa and Domus aided and abetted such breaches.

The Delaware Court of Chancery’s Decision
The Court held that the Pre-Forbearance Directors breached their duty of loyalty and found the Pre-Forbearance Directors liable to BSW for all amounts paid to them and their counsel under the indemnity agreement and further ordered that the bonuses paid as part of the forbearance agreement be disgorged and returned to BSW.

In analyzing whether the Pre-Forbearance Directors breached their duty of loyalty in approving the forbearance agreement, the Court considered whether the benefits the Pre-Forbearance Directors received made them “materially interested.” While the Court noted the receipt of indemnification is “[n]ormally” insufficient to “taint related director actions with a presumption of self-interest,” the Pre-Forbearance Directors had negotiated the forbearance agreement with knowledge that BSW had no “colorable argument” for refusing to seat the Major Stockholder’s board designee and that they therefore faced a “real, unmitigated litigation risk.” The Court noted that the indemnity that the Pre-Forbearance Directors obtained from Domus went “beyond what is provided in the ordinary course” because it indemnified not only claims arising from the forbearance agreement, but also any claims related to BSW asserted by or with Major Stockholder’s assistance; in other words, it was “tailored to specifically address a litigation risk the Pre-Forbearance Directors created for themselves by refusing to seat” Major Stockholder’s designee. Thus, the high risk of litigation and personal liability arising from violating the Major Stockholder’s rights, coupled with the Pre-Forbearance Directors’ insistence on indemnification, made such benefits material enough to make the Pre-Forbearance Directors materially interested.

Because more than half of the Pre-Forbearance Directors were materially interested in the forbearance transaction, the Court applied the entire fairness standard, under which the Pre-Forbearance Directors held the burden of proving that the forbearance transaction was the product of a fair process and resulted in a fair price to BSW. Ultimately, Domus’ agreement to indemnify the Pre-Forbearance Directors provided them a material benefit not shared by BSW or its stockholders, and the Court concluded that Defendants failed to show a fair process or fair price.

Separately, the Court held that at least half of the Post-Forbearance Directors were materially interested in or not independent with respect to the consensual foreclosure because (i) the terms of the foreclosure ensured that the management directors would retain their management positions and retention bonuses, (ii) Versa had selected one of the non-management director’s insolvency company to administer (and receive significant fees from) an assignment for the benefit of creditors anticipated to occur after the foreclosure, and (iii) a Domus-selected director was not independent from Versa and Domus because the director had been appointed to the board of another Versa portfolio company and thus had an expectation of receiving future directorships if he acted in Versa’s best interests. Nevertheless, the directors’ thorough process caused the Court to conclude that these conflicts did not affect their decision-making, and the foreclosure was financially fair given the Company’s financial position and lack of alternatives.

Takeaways for Practitioners

• While the receipt of indemnification is generally insufficient to impugn a director’s independence, this analysis is still highly fact specific, and directors can be deemed materially interested under the circumstances of a particular transaction where it involves a high and specific risk of litigation. Such circumstances may trigger entire fairness review of the underlying transaction, which is the most stringent standard of review under Delaware law. 
• Creditors may be held liable for aiding and abetting where they have knowledge of a potential conflict of interest and exploit that conflict for the creditor’s own benefit.
• If an investor frequently places individuals from a roster of individuals as its director designee, the designated director may be found to expect future selections on the portfolio boards and thus may not be considered independent from the investor.

Background
On January 7, 2025, the Delaware Court of Chancery issued a post-trial opinion in Manti Holdings, LLC v. The Carlyle Group Inc., in which the Court held that the business judgment rule applied to the sale of a company because the private equity controlling stockholder did not have a liquidity-based conflict and its interests were aligned with the minority in the sale. 

In 2017, after years of declining valuations, Authentix Acquisition Company, Inc. (“Authentix”) was sold following an auction process. At the time of the sale, the Carlyle Group Inc. (“Carlyle”) was Authentix’s controlling stockholder, holding 70% of Authentix’s preferred stock and 52% of its common stock. The primary Carlyle fund had a fund life of ten years (expiring in 2017), although the partnership agreement of the primary Carlye funds did not impose a contractual obligation to exit any particular investment at that time.

The plaintiffs, minority stockholders of Authentix, alleged Carlyle compelled the Authentix board to approve a “fire sale” of Authentix to meet Carlyle’s own liquidity needs coinciding with the end of the primary Carlyle fund’s fund life, and argued the Court should apply the heightened entire fairness standard of review. 

The Delaware Court of Chancery’s Decision
The Court concluded the business judgment rule, not entire fairness, was the appropriate standard. The Court recognized that, if plaintiffs established that Carlyle determined it needed to sell immediately, “consequences (and price) be damned, that would create a conflicted controller transaction, and Carlyle would be liable, absent entire fairness.” But neither the contractual arrangements governing the fund nor the evidence introduced at trial supported such a finding.

As for the fund’s term, the Court found that ten years “is the lifecycle typical of most private equity firms,” encompassing periods of fundraising, investing in and working to create value in the companies in which the fund invests, and finally “looking for exit opportunities and to monetize its investments.” The Court acknowledged that a “preference to exit around the ten-year mark exists because when a fund reaches the end of its term, it can no longer obtain additional capital from its investors and thus, cannot make further investments in portfolio companies.” The Court observed, however, that a fund “can continue to hold and manage its remaining portfolio companies after its term ends,” or, alternatively, the general partner can “seek an extension of the fund life” from investors, in which case it could continue to make investments in portfolio companies. Therefore, the ten-year term “did not impose a deadline for selling its portfolio of companies,” and Carlyle “has had funds where they continued to hold investments after term expiration.” In this case, Carlyle investors also approved a two-year extension of the fund’s term. As a result, the Court found that Defendants were not operating under such time pressure “to sell Authentix so that they were willing to do a fire sale of the Company, accepting far less than the fair value of their shares in return for an immediate sale.”

The Court also rejected plaintiffs’ argument that Carlyle received a unique benefit because the sale eliminated the potential for Carlyle, pursuant to the fund’s clawback provisions, to have to return to limited partners distributions it previously received associated with its Authentix investment. The Court found no evidence indicating Carlyle was “so concerned with avoiding a clawback that it was a potent motivator that colored their judgment.” Moreover, the clawback provision had “an incentive structure that does not place pressure on Carlyle’s deal team members to sell portfolio companies at less than fair value in a fire sale.” Instead, the incentive structure implied Carlyle was “interested in selling Authentix because it may decline in value; and that it would be best for all shareholders, regardless of the clawback, to sell before the value further declined.” Because Carlyle did not have any conflicts of interest that triggered entire fairness, notwithstanding its status as the controlling stockholder, the Court reviewed the sale of Authentix under the more deferential business judgment rule, and ultimately found in favor of the defendants.

Takeaway for Practitioners

• Controller transactions are vigorously scrutinized under Delaware law, which mandates that entire fairness review is required where a transaction involves a controlling stockholder who receives a non-ratable benefit.
• Standing alone, ordinary course private equity fund structures and compensation arrangements—for instance, that Carlyle wanted the sale to go forward in 2017 but without an imperative that they needed it to go forward—are insufficient to support a finding that a fund obtained a non-ratable benefit distinct from other stockholders and thus tantamount to a disabling conflict. 
• Even where, as here, a finding that a non-ratable benefit has been sufficiently pled to defeat a motion to dismiss does not mean it cannot be successfully litigated and defeated at trial.

Background
On August 28, 2024, the Delaware Court of Chancery issued a post-trial final report in Peneff Holdings LLC v. Nurture Life, Inc., which addressed the circumstances where a stockholder may waive its right to inspect a corporation’s books and records under DGCL § 220. Nurture Life, Inc.’s (the “Company”) Investors’ Rights Agreement (the “IRA”) required it to deliver to each “Major Investor” certain categories of information within specified time periods. Plaintiff Peneff Holdings LLC (“Peneff”) was initially a Major Investor under the IRA. However, the Company amended the IRA (the “Amended IRA”), which stated that an investor ceased to be a “Major Investor” if the investor or its affiliates engaged in any legal action against the Company. Since one of Peneff’s non-stockholder affiliates was engaged in separate litigation against the Company, the Company took the position that Peneff was no longer a qualifying Major Investor and thus no longer had any inspection rights under the Amended IRA.

The Company contended that Peneff waived its statutory inspection rights because the intent of the inspection rights in the Amended IRA was to supplant all other sources of information rights, including DGCL § 220. The Court held that the Amended IRA was not a waiver of Peneff’s statutory inspection rights.

The Delaware Court of Chancery’s Decision
Setting aside the question of whether a stockholder can waive its statutory inspection rights in a private contract under Delaware law, the Court found that the Amended IRA provided that “a Major Investor is contractually entitled to information; it does not say the inverse—that a stockholder who no longer qualifies as a Major Investor forfeits other information rights.” Thus, the Amended IRA did not “clearly waive Peneff’s statutory inspection rights.”

Takeaway for Practitioners

• While it is unsettled whether a stockholder can waive its statutory inspection rights in a private contract under Delaware law, practitioners should note that any attempt at such a waiver must be clearly stated.

Background
On September 27, 2024, the Delaware Superior Court issued a ruling in Wellgistics, LLC v. Welgo, Inc., which addressed a parent entity’s failure to enforce its subsidiary’s contracts. Welgo, Inc. (the “Parent”) generated revenue through its subsidiary Welgo, LLC (the “Subsidiary”). Due to the Subsidiary’s business, it kept its list of medications and distributors confidential. Shortly after the formation of the Parent, one of its founders sought to sell 50% of the Parent’s Stock to Wellgistics, LLC (“Wellgistics”). During diligence, Wellgistics requested information about the Subsidiary’s products and business. The Parent refused to disclose anything until the parties executed a Mutual Confidentiality Agreement (“MCA”). Once the parties executed the MCA, Wellgistics learned of the identity of the Subsidiary’s medications and distributors.

Thereafter, Wellgistics began purchasing large quantities of the medications that the Subsidiary normally bought and contacted its distributors. The Parent alleged Wellgistics’ actions increased national utilization rates and triggered unwanted scrutiny. As a result, the medications that the Subsidiary normally sold were no longer fully covered by insurance. This reduced the number of medications that the Subsidiary was able to sell, decreasing the Parent’s profit. The Parent—not the Subsidiary—filed suit against Wellgistics for breach of the MCA and for tortious interference.

The Delaware Superior Court’s Decision
Breach of Contract
The Court found that Wellgistics had a duty to only use the confidential information it received under the MCA for the purchase of the Parent’s stock. However, Wellgistics only owed that duty to the Subsidiary—not the Parent. Under Delaware law, a parent entity generally “does not have a claim for improper disclosure of confidential information belonging to a subsidiary.” Here, the Parent alleged disclosure of the Subsidiary’s confidential information—not the disclosure of the Parent’s confidential information. Thus, the Court held that the Parent failed to plead a claim for breach of the MCA.

Tortious Interference
The Parent argued that it was a third-party beneficiary of the Subsidiary’s contracts with its distributors because it wholly-owned the Subsidiary and the Subsidiary was operated for the benefit of the Parent. The Court disagreed. Under Delaware law, a parent entity is not automatically a third-party beneficiary of its subsidiary’s contracts. Further, the fact that the Subsidiary paid some of its revenue to the Parent, made the Parent, at most, an incidental beneficiary; not enough to support a tortious interference claim.

Takeaways for Practitioners

• Under Delaware law, parent entities generally do not have a claim for improper disclosure of confidential information belonging only to a subsidiary, absent clear contractual language providing the parent this right. 
• The fact that a parent entity wholly-owns its subsidiary and receives portions of the subsidiary’s revenue does not automatically make the parent entity a third-party beneficiary to a subsidiary’s contract(s).  

Background
On August 21, 2024, the Delaware Court of Chancery issued an Order in Potts v. SYFS Intermediate Holdings, LLC which addressed the failure to impose implied obligations in the face of clear contractual language. SYFS Intermediate Holdings LLC (“SYFS”) adopted an LLC Agreement that stated managers owe “no fiduciary duties (including duties of care and loyalty) to [SYFS] and the members.” Although the LLC Agreement eliminates fiduciary duties, it does not by its terms and cannot under the Delaware LLC Act eliminate the implied contractual covenant of good faith and fair dealing. Plaintiffs Sybill Potts and others (“Potts”) were unit holders and filed suit against SYFS, challenging its asset sale. Potts alleged that SYFS violated the implied covenant of good faith and fair dealing by obtaining income outside of the LLC Agreement’s waterfall provision through the asset sale. Specifically, Potts argued that the waterfall provision provided the exclusive framework through which SYFS equity holders were to profit from SYFS. SYFS countered that Potts’ argument was “nothing more than a backdoor attempt to assert a claim for breach of fiduciary duty,” despite “an express provision in the [LLC Agreement] that eliminate[d] all fiduciary duties.”

The Court of Chancery’s Decision
The Court held that Potts’ implied covenant claim was nothing more than a backdoor attempt to assert breach of fiduciary duty claims—despite an express provision eliminating such claims. Under Delaware law, the implied covenant of good faith and fair dealing “cannot be used to circumvent the parties’ bargain.” Here, the parties explicitly bargained for and agreed to a provision unequivocally eliminating all fiduciary duties. Thus, the Court dismissed Potts’ implied covenant claim.

Takeaway for Practitioners

• Delaware courts will seldom entertain arguments for breach of fiduciary duties with a limited liability companies where the parties explicitly eliminated them.

Background
Two Delaware decisions recently sustained implied covenant claims challenging the termination of at-will corporate officers. In Schatzman v. Modern Controls, Inc., a corporate officer (“Schatzman”) was contractually entitled to 10% of the net proceeds from a sale of his employer if the sale occurred during his employment. The Company terminated Schatzman after investigating several employee complaints against him for harassment and defamation; several months later, the company announced a sale. Schatzman claimed that his termination violated the implied covenant of good faith and fair dealing, notwithstanding his status as an at-will employee, because, he alleged, the company terminated him in bad faith for the “improper purpose” of depriving him of his share of the sale proceeds. Denying the employer’s motion to dismiss, the Superior Court found that Schatzman sufficiently alleged that his employer terminated him for an improper purpose because, before his termination, his employer did not give him information about the accusations against him, no opportunity to participate in the investigation, and no forum to defend himself.

Roth v. Sotera Health Co. concerned a dispute about a former corporate officer’s (“Roth”) unvested equity units in his employer (the “Company”). The units were to vest if the Company’s private equity sponsor received cash distributions equal to a specified return rate on their investment; however, the units would be forfeited if they remain unvested when Roth’s employment ended. Roth resigned after receiving a demotion, and sued the Company for the value of his equity. Roth argued that the Company violated the implied covenant of good faith and fair dealing by constructively terminating him in bad faith to cause a forfeiture of his equity. The Court of Chancery sided with Roth and denied the Company’s motion for judgment on the pleadings.

Delaware courts are generally hesitant about recognizing the implied covenant in at-will employment contracts, but they recognize an exception where the employer “uses its superior bargaining power to deprive an employee of compensation that is clearly identifiable and is related to the employee’s past services.” The Court found that Roth sufficiently plead bad faith based on his allegations that the Company’s CEO “felt that [his] equity package was excessive and manufactured reasons for his demotion to avoid paying him for it” and that the company’s board of directors “took no efforts towards meeting the vesting conditions.”

Takeaways for Practitioners

• Delaware courts are hesitant to recognize implied covenant claims in the context of an at-will employment contract but may do so “where the employer used its superior bargaining power to deprive an employee of clearly identifiable compensation related to the employee’s past service” (as in Sotera) or “where the employer falsified or manipulated employment records to create fictious grounds for termination” (as in Schatzman).
• Bad faith may arise when a corporate officer is terminated in circumstances that suggest the company was motivated by a desire to avoid paying a benefit tied to the officer’s continued employment.

Background
On September 23, 2024, the Court of Chancery issued a ruling in Roth v. Sotera Health Co., which addressed a compensation dispute between an officer and his former employer relating to his unvested equity.

Plaintiff Kurtis Roth (“Roth”) was a former officer of Defendant Sotera Health Company’s (“Sotera”) operating subsidiary, as well as a member of Sotera holding Class B-2 Units. Pursuant to Sotera’s limited liability company agreement (the “LLC Agreement”), Class B-2 Units would vest if Sotera’s private equity sponsors received a specified multiple on their investment. However, any Class B-2 Units that remained unvested at the time Roth’s employment was terminated would be forfeited.

In 2016, Sotera was converted to a limited partnership and its limited partnership agreement (the “L.P. Agreement”) retained the same vesting and forfeiture term for Class B-2 Units set forth in the LLC Agreement.

In 2020, Sotera became a public corporation, and Roth executed a restricted stock agreement (the “RSA”) pursuant to which Roth’s Class B-2 Units were exchanged for restricted shares of common stock (the “Restricted Stock”). Notably, the RSA incorporated the terms of the L.P. Agreement by reference, generally providing unvested shares of Restricted Stock would be subject to the same vesting and forfeiture restrictions that applied to unvested Class B-2 Units.

In 2022, Roth resigned and was advised that his unvested shares of Restricted Stock would be forfeited. Roth then filed this action.

The Chancery Court’s Decision
On summary judgment, the Court held that the pre-IPO vesting and forfeiture terms applied to the Restricted Stock Roth received in exchange for his Class B-2 Units. The Court noted that the terms of the LLC Agreement were “carefully revised” into the L.P. Agreement when Sotera converted from a limited liability company to a limited partnership. Specifically, the Court highlighted that the defined terms in the LLC Agreement matched those in the L.P. Agreement. The RSA, on the other hand, “simply incorporate[d] the terms of the [L.P. Agreement] by reference.” The Court highlighted that this practice created several “ill-fitting” terms. Nevertheless, the Court found that “sloppy drafting does not necessarily create ambiguity.”

Despite the RSA’s “imperfect[ions],” the Court held that the LLC Agreement’s vesting and forfeiture terms, which “carried forward in identical provisions” in the L.P. Agreement, “continue[d] to apply to Roth’s unvested Sotera stock” through the RSA’s “clear incorporation provision,” which expressly stated those terms were “incorporated herein by reference as if fully set forth herein.” Accordingly, any shares of Restricted Stock that were unvested when Roth left Sotera were “forfeited and cancelled for no consideration.”

Finally, the Court rejected Roth’s argument that the incorporation failed under 8 Del. C. § 202(a) because the restrictions on his shares were not “contained in the notice or notices” provided with the stock grant. Section 202(b) allows restrictions to be imposed “by an agreement . . . among . . . security holders . . . and the corporation,” and Section 202(a) includes an exception for “persons with actual knowledge of the restriction.” Thus, the Court found that Roth had “signed and consented to the [RSA], which incorporate[d] vesting and forfeiture provisions he had been aware of since 2015.”

Takeaways for Practitioners

• When incorporating another instrument by reference, Practitioners should consider whether any of the terms to be incorporated (especially defined terms) are “ill-fitting” for the instrument interpreting them. For example, avoid incorporating terms by reference from an earlier instrument that refer to an entity as the “Partnership” into a later contract if the entity has since been re-organized into a limited liability company or a corporation.
• Even if “sloppy drafting does not necessarily create ambiguity” in a contract, it may still invite otherwise avoidable litigation.