Important Disclaimer Delaware Chancery Court Issues a Trio of Opinions Reminding Boards and Corporate Counsel to Carefully Review Corporate Contracts and Documents April 9, 2008 One of the basic principles when litigating in the Delaware Chancery Court is to understand that the court strictly interprets contracts, particularly when those contracts are the result of negotiations between sophisticated parties and/or drafted by corporate counsel. This lesson was reinforced by the court in a trio of recent opinions, including highly publicized decisions arising out of the battle for control of the CNET board and the dispute between John Malone and Barry Diller for control over IAC Interactive. In both of these cases, as well as a third litigation involving a party's contractual "right to match" a third-party offer, the court found that contractual language, whether contained in bylaws, voting agreements, or other contracts, will be read quite literally absent some equitable reason to the contrary. As part of this analysis, the court reinforced one of the bedrock principles of Delaware corporate law: that sophisticated parties should be—and will be—held to their contractual rights and obligations, even as circumstances change. This is an important lesson to remember, particularly in an age where provisions in merger contracts are increasingly in dispute, as well as when a company's articles and/or bylaws—both of which are a form of contract—may be challenged. JANA Master Fund, Ltd. v. CNET Networks, Inc.1 On March 13, 2008, the Delaware Chancery Court held that JANA Master Fund, Ltd.'s (JANA's) independently funded proxy solicitation to obtain majority control of the board of directors of CNET Networks, Inc. (CNET, or the company) was not prohibited by CNET's bylaws. Specifically, the court ruled that a provision in CNET's bylaws stating that a shareholder must own company stock for a full year before seeking "to transact other corporate business" at the annual meeting did not apply to JANA's actions because other language in the bylaw made it clear that the bylaw only applied to situations in which a shareholder was seeking to put their proposal on the company's proxy statement. The case arose out of JANA's effort to obtain control of the CNET board. JANA and its affiliates own approximately 11 percent of the outstanding common stock of CNET. CNET's certificate of incorporation and bylaws provide that CNET has a classified board, and two of the eight members of the board are up for election this year. In an effort to take control of the board without having to win the two elections ordinarily required when a company has a classified board, JANA gave notice to CNET that JANA intended to take a number of actions at CNET's upcoming annual meeting, including to (i) contest the election of the two seats up for election this year; (ii) amend CNET's bylaws to expand the number of board seats from eight to 13; and (iii) nominate five individuals to fill the newly created board positions. If CNET's shareholders approved all of JANA's proposed amendments as well as JANA's candidates for the CNET board, then these new candidates would constitute a majority of CNET's directors. On December 26, 2007, JANA informed CNET of its intention to solicit proxies in favor of its nominees and proposals, and requested inspection of CNET's stocklist materials. On January 3, 2008, CNET responded and refused to provide the requested stocklist materials on the basis that JANA failed to state a proper purpose because the proposed proxy solicitation violated CNET's bylaws. Specifically, CNET cited JANA's "fail[ure] to comply with the provisions of the Company's bylaws which require a shareholder seeking to nominate candidates for director election or seeking to transact other corporate business at an annual meeting to beneficially own $1,000 of the Company's common stock for at least one year." According to CNET, JANA made its initial investment in CNET stock in October 2007, and will have held shares of CNET for only eight months at the expected time of the annual meeting in June 2008. Thus, CNET argued that under the company's bylaws JANA was not entitled to either nominate candidates or "transact other business" in connection with the company's 2008 annual meeting. On January 7, 2008, JANA filed a declaratory relief action asking the court to find either (i) that the bylaw at issue was inapplicable to JANA because it was clearly intended to apply solely to solicitations under SEC Rule 14a-8,2 or (ii) that CNET's interpretation of the bylaws was invalid under Delaware law. In response, CNET argued that its "Notice Bylaw" was not intended to be limited to solicitations under Rule 14a-8, but rather governs all shareholder nominations for directors and other shareholder proposals. CNET further argued that the bylaw was not illegal because it was validly adopted under Delaware law, is not prohibited by the Delaware General Corporation Law, and reasonably serves a valid corporate purpose. CNET's bylaw provision states, in pertinent part, as follows: "Any stockholder of the Corporation that has been the beneficial owner of at least $1,000 of securities entitled to vote at an annual meeting for at least one year may seek to transact other corporate business at the annual meeting, provided that such business is set forth in a written notice . . . and received no later than 120 calendar days in advance of the date of the Corporation's proxy statement released to security-holders in connection with the previous year's annual meeting of security holders . . . . [S]uch notice must also comply with any applicable federal securities laws establishing the circumstances under which the Corporation is required to include the proposal in its proxy statement or form of proxy." (Emphasis added.) In reviewing these contentions, the court ruled as a matter of law that the "language of the Notice Bylaw leads to only one reasonable conclusion: the bylaw applies solely to proposals and nominations that are intended to be included in the company's proxy materials pursuant to Rule 14a-8." The court stated that there were three reasons it concluded that the bylaw could only be read to apply to proposals under Rule 14a-8. First, the court found that while shareholders "may seek" to bring proposals under Rule 14a-8, outside of that rule shareholders simply "may bring" such proposals, and do not need permission to bring proposals or conduct business at the company's annual meeting. The court stated that the language "may seek" that is used in the bylaw was a key consideration in its analysis, and that the phrase suggests that a shareholder must ask for permission or approval to make such a proposal, which envisions use of the company's proxy under Rule 14a-8. However, if a shareholder wishes to put a proposal before fellow shareholders in the form of an independently financed proxy solicitation, that shareholder is not required to "seek" the board's approval. Because JANA intends to finance its own proxy solicitation, the "may seek" language indicated that the Notice Bylaw does not apply to JANA's proposals. Second, the court noted that the Notice Bylaw established a deadline in order to permit the corporation to include approved proposals in its form of proxy, and stated that this was another indication that the bylaw did not apply to JANA's independently funded proxy solicitation. The court stated that the most reasonable explanation for such a requirement is that the bylaw was designed to allow the board time to include the shareholder proposal in its own proxy materials, and noted that a similar requirement is established by Rule 14a-8 itself. Third, the court found that the final sentence of the Notice Bylaw clearly referred to Rule 14a-8, and defined its scope by referring to the "applicable federal securities laws" that establish "the circumstances under which the Corporation is required to include" shareholder proposals in proxy materials. The court held that the "specific language used in the final sentence of the bylaw mandates [the] conclusion that the bylaw only applies to Rule 14a-8 proposals." In construing CNET's bylaws in this manner, the court explicitly did not rule on the broader question of whether a bylaw requiring shareholders to own stock for a certain period before nominating directors or conducting other business at a shareholder meeting is valid under Delaware law.3 However, the case is currently on appeal and it is possible that this issue will be addressed in a subsequent opinion. In re IAC/InterActive Corp.4 On March 28, 2008, the Delaware Chancery Court, in a 78-page decision, rejected Liberty Media Corp.'s (Liberty's) attempt to block IAC/InterActive Corp.'s (IAC's) plan to spin off four of its subsidiaries notwithstanding Liberty's ownership of IAC stock having a majority of the voting power. IAC has a dual-class voting structure in which Liberty owns all of the Class B common stock constituting a majority of the voting power of IAC. However, Liberty had granted an irrevocable proxy to Barry Diller, IAC's chairman and CEO, to vote all of the IAC shares beneficially owned by Liberty or its affiliates. Thus, while Liberty owned the shares, Diller had the ability to exercise the majority voting power. In November 2007, the IAC board of directors preliminarily approved the general terms of the spin-off of four of its subsidiaries. A dispute arose between IAC and Liberty over the question of whether or not to replicate IAC's two-tiered voting structure in the spin-off companies. Liberty took the position that various provisions of the stockholder and governance agreements entered into by the parties required that Liberty give its consent to a single-tier spin-off and required Diller to oppose any such transaction if Liberty did not consent. Despite the fact that Liberty did not consent, on January 16, 2008, at a meeting of the IAC board of directors, Diller informed John Malone, Liberty's chairman, that he would recommend a single-tier spin-off and would vote Liberty's shares in favor of that proposal. On January 22, 2008, IAC filed a complaint seeking a declaratory judgment that a single-tier structure would not violate the terms of the relevant agreements. Liberty countersued for declaratory relief, asserting that the proxy to Diller had been terminated as the result of Diller's repudiation of his contractual duties, and Liberty executed and delivered written consents purporting to (i) amend IAC's bylaws, (ii) remove seven IAC directors including Diller, and (iii) appoint new directors to IAC's board. That same day, Liberty and its affiliates brought suit pursuant to Section 225 of the Delaware General Corporation Law seeking an order validating their actions. The court consolidated the three actions and conducted a five-day trial on March 10-14, 2008. Liberty's claim centered on the language of Section 2.03(a) of the 2005 Governance Agreement between the parties, which granted Liberty certain consent rights with respect to defined matters. Liberty contended that the 2005 Governance Agreement gave it a right of consent to any single-tier spin-off. The court noted that the real issue in dispute was whether or not Liberty's interpretation was wrong. If it was, the proxy previously given to Diller would remain in effect, and the purported written consents would be null and void, because Diller could not be deemed to have repudiated his obligations to Liberty. By its express terms, Section 2.03(a) only applies in the event of "any transaction not in the ordinary course of business, launching new or additional channels or engaging in any new field of business" that is likely to result in certain adverse consequences, defined as "[1] being required under law to divest itself of all or any part of its Beneficial Ownership of Company Common Shares, or interests therein, or any other material assets . . . ; [2] or that will render such Person's continued ownership of such securities, shares, interests or assets illegal or subject to the imposition of a fine or penalty . . . ; [3] or that will impose material additional restrictions or limitations on such Person's full rights of ownership (including, without limitation, voting) thereof or therein." The dispute centered on the third clause, and in particular on whether this third clause was related to the regulatory issues in the first two clauses or was broader and applied to any action. According to IAC, all three clauses related exclusively to regulatory matters. Liberty argued that the third clause was not limited to regulatory matters, but rather was a type of "catch-all" clause that prevented Diller or IAC from depriving Liberty of the attributes of its controlling position in IAC. Liberty contended that the spin-off should not be allowed because it imposes "material additional . . . limitations on Liberty's full rights of ownership" because of its "dilutive and value destroying effects" on Liberty's interest in IAC. The court held that the "clear regulatory scope of clauses [1] and [2] requires the court to read the general language of the Third Clause as being related to the same subject matter." The court also stated that since the third clause contains more general terms than the two preceding clauses, it is appropriate to confine the third clause to the regulatory subject evidenced in the first two clauses of Section 2.03(a). The court found further support for the conclusion that Section 2.03(a) is regulatory in purpose in the final sentence of Section 2.03(a), which provides that its provisions "will be applied based only on the Beneficial Ownership of Company shares, interests or other material assets of Liberty . . . as of the date hereof." The court stated that "[t]his restriction evinces the regulatory scope of all of section 2.03(a) because it is intended to prevent Liberty from expanding its right to consent to transactions acquiring additional shares or other assets. Such a limitation is clearly grounded in regulatory concerns." (Emphasis in original.) For all of these reasons, the court stated that the "only sensible conclusion is that the Third Clause unambiguously applies solely to regulatory matters."5 Smartmatic Corp. v. SVS Holdings, Inc., et al.6 On April 4, 2008, the Delaware Chancery Court, in a letter opinion, denied SVS Holdings, Inc., and Sequoia Voting Systems, Inc.'s (collectively, SVS's) requests for declaratory and injunctive relief in connection with Hart InterCivic, Inc.'s (Hart's) purchase of an unsecured promissory note that SVS had given to Smartmatic Corporation (Smartmatic) (the note) in connection with a stock-purchase agreement between SVS and Smartmatic (the SPA). The terms of the SPA expressly allow Smartmatic to sell the note to a third party, provided that Smartmatic gave SVS notice of any bona fide offer it received as defined under the SPA (the sale notice) and gave SVS 60 days to match that offer. Thereafter, if SVS chose not to exercise its right to match, each holder of SVS stock would have 15 days in which to notify Smartmatic that it intended to exercise a "put right" pursuant to which the holder would receive the same consideration to be received by Smartmatic in the offer. In accordance with the terms of the SPA, Hart offered to purchase the note, subject to due diligence and other standard conditions (the Hart offer). On February 19, 2008, SVS notified Smartmatic that it would not allow Hart to conduct due diligence, asserting that the SPA prohibited a party making an offer to begin due diligence until after the 60-day "match" period expired. On February 28, 2008, Smartmatic filed a complaint seeking a declaration that Hart was entitled to due diligence immediately.7 On March 10, 2008, SVS filed an answer, counterclaims, and a third-party complaint against Hart, claiming, among other things, that Hart's offer was not a bona fide offer under the terms of the SPA, that the notice provided by Smartmatic and Hart was not sufficient because the Hart offer was subject to due diligence and other conditions, and that Hart's offer was too vague to trigger the "put right." From March 14 through March 20, 2008, all of the parties moved for summary judgment. SVS sought declarations that, among other things, (i) the Hart offer was not a bona fide offer and did not meet the minimum requirements of the sale notice, and (ii) even if the Hart offer constituted a bona fide offer triggering the right to match, the Hart offer was insufficient to trigger the conversion rights outlined in the note.8 The court rejected the notion that the Hart offer was not a bona fide offer, and held that "[t]here cannot be any question that the offer was made in good faith, given its structure and terms." The Hart offer included an agreement to pay a substantial amount of money on closing, as well as a percentage of the net income of a combined Hart/SVS company for a fixed number of years, with a promise to pay a specified minimum amount in that same fixed time period. The court also noted that Hart had placed money in escrow to effect the transaction. The court also disposed of SVS's argument that the sale notice had to include all information necessary for SVS to decide whether to exercise its right to match, including the exact amount of money the SVS shareholders would receive upon selling stock to Hart pursuant to the put right. SVS argued that the Hart offer did not meet this requirement because it did not reference the SVS shareholders' put right at all, much less the specific amount of money the SVS shareholders would receive upon putting their stock to Hart. The court rejected SVS's argument, finding that "SVS can point to no language in the SPA or the Note requiring that the Sale Notice include any reference to the put right. To the contrary, article 11.1 of the SPA specifically provides that the put right will be 'included in any agreement of sale,' a step in contract negotiations occurring after the 'bona fide offer' constituting the Sale Notice under article 8.16 is made." The court also noted, as discussed in more detail below, that nothing in the SPA or note prohibited Hart from paying for any shares under the put right over time and for a contingent price, and that it would be anomalous to recognize that fact and still require Hart to assign a concrete value to those shares in the sale notice. Finally, the court rejected SVS's assertion that the put right required Hart to pay either its entire offer or at least the portion to SVS's shareholders in full at closing for similar reasons. Once again, the court focused on the specific language in the SPA, as well as the fact that the language sought by SVS was not included in the SPA. Thus, the court rejected SVS's argument that the Hart offer was improper under the terms of the SPA because it included payments over a period of years, holding that "[n]either the SPA nor the Note contain such a requirement. If the parties intended payment in full upon closing, they could have stated that intention." The court further noted that the requirement with respect to the put right was that Hart pay the tendering shareholders the same consideration as it would pay Smartmatic, not that it pay these shareholders in full, upon closing, recognizing that "[t]he parties could have, of course, provided for such a requirement, but did not." Lessons from JANA, IAC, and Hart There are a number of lessons that may be taken from these recent decisions by the Delaware Chancery Court that are important to directors and corporate counselors: - You Will Be Held to Your Bargain. At the end of the day, notwithstanding sophisticated issues, high stakes, publicity, and other factors, the focus of the Chancery Court's decision in all of these cases was the literal language of the agreements at issue. The Delaware courts have a long history of enforcing commercial agreements between sophisticated parties, and recognize the importance of contractual rights. These cases serve to remind directors, transactional lawyers, and litigators that a crucial first step when approaching litigation in Delaware is to focus on the language of the agreement at issue. For this reason, close coordination between transactional lawyers, litigators, and principals at the time of deal formation is critical, so that there can be a discussion at that time about how particular language may be construed in any subsequent litigation.
- Less Can Be More. Sophisticated agreements related to complex transactions are often complicated documents, and frequently subject to a variety of interpretations. Negotiations can lead to ambiguity at times, and indeed there may even be good business and other legitimate reasons for some uncertainty in the terms of certain documents.9 However, there may be a price for this uncertainty, as it will make the resolution of any litigation more difficult. On the other hand, an agreement which is clearly drafted and has simple and unambiguous language will be a considerable benefit in any subsequent litigation (assuming, of course, the language supports the legal argument).
- Make Sure Your Understanding Is Made Clear to Others. In the IAC case, a Liberty lawyer testified that he always viewed the third clause of Section 2.03(a) as a catch-all. However, the lawyer admitted that he never conveyed this understanding to IAC or its lawyers, and was not able to point to any writing that supported his contention. The court did not find this testimony compelling, and generally Delaware courts do not find this type of subjective intent or understanding very persuasive. "In cases where the extrinsic evidence does not lead to a single, commonly held understanding of a contract's meaning, a court may consider the subjective understanding of one party that has been objectively manifested and is known or should be known by the other party" (United Rentals, Inc. v. RAM Holdings, Inc., 937 A.2d 810, 835 (Del. Ch. 2007)). (Emphasis added.) In short, if you have not made your understanding of the document clear to the other side, and if there is no contemporaneous written evidence supporting your view, after-the-fact testimony provided in litigation may not be given significant weight by the court.
- Review Your Bylaws. The JANA decision raises several issues for companies. First, the bylaw language contained in JANA is not uncommon, and companies and their counsel should carefully review the company's bylaws to ensure that the document provides the types of provisions that the board believes are appropriate in a sufficiently clear manner. One obvious area to review is the advance-notice provision. Indeed, it is worth noting that the court in JANA recognized the potential vulnerability to CNET by reading the bylaw in the manner that it did—the court specifically stated that one practical effect of its decision is that "any of CNET's thousands of shareholders are free to raise for the first time and present any proposals they desire at the Annual Meeting," not a position most companies wish to be in. Yet perhaps an even more significant issue to consider, which was left unresolved by the Chancery Court's decision in JANA, is whether a company can restrict shareholder action by holders who have only recently acquired the company's stock. On this issue, it is worth noting that there is no express provision in the Delaware General Corporation Law that prohibits this type of bylaw, and it would seem that a board could reasonably conclude that in order to bring a shareholder proposal, a shareholder needs to demonstrate their long-term commitment to the company by being a shareholder for a certain period of time. It will be interesting to see if the Delaware Supreme Court considers this issue in connection with the appeal by CNET and/or how ISS or other corporate governance activists respond to such a bylaw.
Should you have any questions about any of these cases or issues, please feel free to contact David J. Berger or Elizabeth M. Saunders in Wilson Sonsini Goodrich & Rosati's litigation department.
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