Hopkins v. Duckett (N.J. App. Div. January 17, 2012) involved a long-running dispute between members of an LLC over, among other things, whether the founder could be expelled after he changed his mind on a promise to retire. The founder sued claiming that his ouster constituted “oppression.”
The Court held that the founder could not assert an oppression claim because the LLC, Nightingale & Associates, L.L.C. (N&A) was a Delaware LLC and Delaware did not recognize a claim for oppression (more on this below).
However the Court also ruled that even if N&A had been governed by New Jersey law, the founder’s claim would fail because New Jersey’s oppression cause of action applies only to corporations, and not to LLC’s. The Court was very clear and concise on this point in its January 17, 2012 decision:
]]>First, the privilege applies only to communications made in the context of an attorney-client relationship for the primary purpose of securing either a legal opinion or legal services. Only such communications are protected.
Second, since the purpose of the privilege is to encourage open communication between a client and attorney, the privilege also protects communications if they would tend to disclose the client's confidential communications. Thus, if there was an expectation of confidentiality the attorney-client privilege would apply.
Third, for anyone considering seeking counsel from an attorney, it is important to know that not all communications made between a client and his or her attorney are protected under the attorney-client privilege.
]]>The implied covenant of good faith and fair dealing is inherent to every contract. It “requires a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits of the bargain.” Dunlap v. State Farm Fire & Cas. Co., 878 A.2d 434, 442 (Del. 2005). A party is liable for breaching the covenant when its conduct “frustrates the overarching purpose of the contract by taking advantage of [its] position to control implementation of the agreement’s terms.” Id. While it may be unclear as to when courts should implement implied covenant analysis, a recent Delaware decision, Winshall v. Viacom Int’l Inc., No. 6074-CS (November 10, 2011), sheds some light on the issue.
In Winshall, defendant Viacom had acquired defendant Harmonix Music Systems, Inc., creator of the music-oriented video games Rock Band and Guitar Hero, in a 2006 merger. Under the merger agreement, Viacom promised the Selling Stockholders an up-front payment of $175 million for their shares, as well as the contingent right to receive uncapped earn-out payments based on Harmonix’s financial performance in the two years following the Merger, 2007 and 2008.
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The implied covenant of good faith and fair dealing is inherent to every contract. It “requires a party in a contractual relationship to refrain from arbitrary or unreasonable conduct which has the effect of preventing the other party to the contract from receiving the fruits of the bargain.” Dunlap v. State Farm Fire & Cas. Co., 878 A.2d 434, 442 (Del. 2005). A party is liable for breaching the covenant when its conduct “frustrates the overarching purpose of the contract by taking advantage of [its] position to control implementation of the agreement’s terms.” Id. While it may be unclear as to when courts should implement implied covenant analysis, a recent Delaware decision, Winshall v. Viacom Int’l Inc., No. 6074-CS (November 10, 2011), sheds some light on the issue.
In Winshall, defendant Viacom had acquired defendant Harmonix Music Systems, Inc., creator of the music-oriented video games Rock Band and Guitar Hero, in a 2006 merger. Under the merger agreement, Viacom promised the Selling Stockholders an up-front payment of $175 million for their shares, as well as the contingent right to receive uncapped earn-out payments based on Harmonix’s financial performance in the two years following the Merger, 2007 and 2008.
About one year after the Merger closed, Harmonix released a new video game, Rock Band and had already entered into an agreement with Electronic Arts, Inc. (“EA”) for the distribution of Rock Band through March 2010. However, due to the game’s popularity, EA wanted to renegotiate the contract in 2008 to gain a broader scope of rights to Rock Band and its sequels. Because of EA’s interest in amending the distribution agreement, Harmonix and Viacom allegedly had an opportunity to negotiate for an immediate reduction in distribution fees that would have potentially increased the Selling Stockholders’ earn-out payments for 2008. But, at the direction of Viacom, Harmonix did not amend its contract with EA so as to immediately reduce its distribution fees. Rather, Harmonix and EA’s amended agreement involved a reduction in distribution fees in upcoming years, after the expiration of the earn-out period. The revised contract also granted EA a number of important new rights having nothing to do with EA’s already firm right to distribute Rock Band during 2008. On behalf of the Selling Stockholders, Winshall sued Viacom and Harmonix, alleging that Viacom and Harmonix purposefully renegotiated the distribution contract with EA so as to reduce the earn-out payments payable to the Harmonix stockholders, and thus breached the covenant of good faith and fair dealing implied in the merger agreement.
Winshall’s view of the implied covenant would require that a party to an agreement not simply refrain from upsetting the fundamental expectations of the other party, as implied by the explicit terms of the deal, but actually improve that deal by expanding its contractual counterparty’s expectancy. The Court rejected this view and determined that while Viacom and Harmonix were under an implied duty not to reduce any reasonable contractual expectation of the Selling Stockholders, they were not obligated to take any and all opportunities during the earn-out period to increase the earn-out payment for 2008, regardless of whether that opportunity was offered to Viacom and Harmonix in exchange for granting the counterparty rights to future assets in which the recipients of the earn-outs had no reasonable expectancy interest. In dismissing Winshall’s claim, the Court concluded that the facts do not support an inference that Viacom and Harmonix acted to deprive the Selling Stockholders of their reasonably expected benefits under the Merger Agreement and that the Selling Stockholders had no legitimate expectation that, if Harmonix was offered a chance to renegotiate the amount of distribution fees payable under a distribution agreement that was entered into after the Merger, it would choose a structure that benefited the Selling Stockholders and increased the amount of already unlimited earn-out payments that it was obligated to make under the Merger Agreement.
In the Winshall decision, the Court also clarified the application of the covenant. “[I]mplied covenant analysis will only be applied when the contract is truly silent with respect to the matter at hand, and only when the court finds that the expectations of the parties were so fundamental that it is clear that they did not feel a need to negotiate about them.” Allied Capital Corp. v. GC-Sun Holdings, L.P., 910 A.2d 1020, 1032-33 (Del. Ch. 2006). Further, the implied covenant is not a license to rewrite contractual language just because the plaintiff failed to negotiate for protections that, in hindsight, would have made the contract a better deal. When conducting an analysis of whether a party breached the implied covenant of good faith and fair dealing, the court “must assess the parties’ reasonable expectations at the time of contracting and not rewrite the contract to appease a party who later wishes to rewrite a contract he now believes to have been a bad deal.” Nemec v. Shrader, 991 A.2d 1120, 1126 (Del. 2010).
]]>In a recently issued opinion in Feinberg v. Silverberg, 2011 NY Slip Op 32299 (Nassau Co. 2011), Nassau County Supreme Court granted injunctive relief preventing Defendant from continuing oppressive acts. The case strongly supports the proposition that when an oppressed shareholder stands to lose his stake in control and management of a corporation, money damages are not sufficient compensation and an injunction provides greater equity as relief.
L&E is a closely held corporation founded by Feinberg, Plaintiff, and Silverberg, Defendant, who are both 50% shareholders. Feinberg is the President and Treasurer; Silverberg is the Vice President and Secretary. Victor Hecht, another named Defendant, is the Chief Financial Officer of L&E, and Brian Barney is an employee with responsibilities involving the business of L&E in Asia.
]]>Fender v. Prescott, 101 A.D.2d 418,422 (1st Dept. 1984):
[T]he relationship between shareholders in a close corporation, vis-à-vis each other, is akin to that between partners and imposes a high degree of fidelity and good faith.
As was observed by Chief Judge Cardozo in Meinhard v. Salmon, 249 N.Y. 458, 164 N.E. 545, 546 (1928) : "A trustee is held to something stricter than the morals of the market place. Not honesty alone, but the punctilio of an honor the most sensitive, is then the standard of behavior."
The strict standard of good faith imposed upon a fiduciary may not be so easily circumvented.
Often the minority shareholder – having lost his job and means of support or being compelled to sell his interest in his business – will be under significant pressure to accept an offer that provides him some continuing income or compensation – even if it is much less than what he might legally be entitled to or could negotiate for is he were not under duress.
]]>Being a defendant in a shareholder oppression case can pose a significant threat to a closed corporation and its majority shareholders. Not only can the majority or the corporation be forced to buy out the shares of the minority at what the court determines to be “fair value,” the litigation itself can be a significant distraction and drain on company finances and managerial resources.
“Fair value” often involves an appraisal process, expert reports and expert testimony at a trial – and great uncertainty as to what the court will ultimately decide. “Fair value” is a technical legal terms that is a legislative and judicial creation; it is not the same as “fair market value” and it can often be substantially different from what the minority’s shares can fetch in the open market or the amount of financing a company can obtain to buy these shares.
]]>This is in part due to the fact that federal and state securities laws generally contain “in connection with” language – i.e., these laws define a securities violation as the commission of a fraudulent act “in connection with the purchase or sale” of a security.
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