Summary:  Two recent decisions (in Delaware and Georgia) point out legal landmines when negotiating with potential business partners.  Even though the decisions point in opposite directions, they also point out the need for clear drafting.  One is about LOIs:  Make it clear what is binding and what is not and terms like “good faith” actually have a meaning.  The second, in Georgia:  Make certain your NDAs are well-drafted especially when revealing trade secrets, e.g., draft for limited disclosure for limited purposes and with constraints on competing products.

The Details.

Two companies entered into an LOI under Delaware law and one of the two claimed that the other party did not act in good faith in accordance with the terms of the LOI and breached the exclusivity and confidentiality provisions.  Please note that this was a decision only for a preliminary injunction.

In the second situation (this one an appeals court decision in Georgia), a company with a good idea (and some code) approached a couple of other companies about developing and selling a software product based on that idea and code.  The first sale would be to a large insurance company known by all of the parties.  So, the parties signed NDAs.  Well, oops:  Two parties decided to create their own product that was pretty similar to what was being developed and they went on to try to sell it as planned.  But guess what?  Both the trial court and the court of appeals held that there was no breach of the NDA (which was itself badly drafted, according to the court).

So What?

So, when it comes to an LOI, it is not an unenforceable “agreement to agree” but an actual agreement with specified rights and obligations.  As the Delaware opinion stated, parties “[. . .] enter into [LOIs] for a reason.  They don’t enter into them because they are gossamer and can be disregarded whenever situations change.  They enter into them because they create rights.”  What to do?  Well, this court opinion says that parties can specify what is binding and what is not binding.  Naturally, the opinion applies only to Delaware law but its principles extend to just about any LOI or term sheet.  In particular, once a document is found to be an agreement, then covenants of “good faith” are incorporated into the deal.  Pay attention.

As to NDAs, too little attention is paid to their precise terms—in other words, someone exhumes an earlier version and replaces the names of the parties.  This is not smart.  For example, specify—and we mean really specify—the purpose(s) to which the confidential information can be used.  Define “confidential information” so that the person providing that material can control the information.  This also means that one needs to make it clear whether or not copies of the confidential information can be provided and who has access to that information.

OK, OK, so we sound like a broken record:  Pay attention to the agreements and, almost as obvious, make sure that the behavior of both (or all) parties comports not just with the agreements but also to expectations.  Agreements are only a part of the relationship;  behavior is another large part.

James C. Roberts III (jcrext@globalcaplaw.com) is the Managing Partner of Global Capital Law Group and CEO of the strategic consulting firm, Global Capital Strategic Group.  He heads the international, mergers & acquisitions and transactional practices and the industry practices concentrating on digital, media, mobile and cleantech technologies.  He is currently involved in opening the Milan office for Global Capital.  Mr. Roberts speaks English and French.  He received his JD from the University of Chicago Law School, his MA from Stanford University and his BS from the University of California—Berkeley.

Global Capital (www.globalcaplaw.com) counsels domestic and international clients on legal issues inherent in the deployment of intellectual & financial capital—a merger or acquisition, foreign market expansion, a strategic alliance, a digital content license, a mobile deal, foreign and domestic labor and employment policies, starting a new entity or raising capital. Clients range from global Fortune 100 corporations such as Deutsche Bank and News Corporation and its subsidiaries, MySpace.com and Fox Interactive Media, to start-ups.  Industries represented include digital media, Internet, software, medical and biotechnology, nanotechnology, consulting firms, environmental technology, advertising, museums and other cultural institutions and manufacturing.

We often circulate what we call “QuickBlasts,” which discuss, very briefly, what we think are interesting or important developments. Below is the text of one such QuickBlast–on a major case from the Delaware Supreme Court:

Fiduciary Duties Expanded & Director Independence Examined

The Gantler v. Stephens decision by the Delaware Supreme Court on January 27, 2009 changes the game, so to speak, for directors and officers liability, among other things.  While the decision relates to board action involving an abandoned merger, the decision will affect many significant actions by directors and by officers.  Taken with other recent Delaware decisions (e.g., Lyondell), it should be clear that the Delaware courts are tightening the screws on those who run companies.   In a sense, the court once again reminds the corporate world that reality matters.

In a Nutshell.

Very briefly: The Delaware Supreme Court reversed a lower court’s ruling and denied a motion to dismiss a challenge by a shareholder (who was also a former director).  The board had engaged an investment bank that had found some potential acquirers.  At some point during due diligence the board abruptly abandoned discussions with the potential acquirers.   Several weeks later the board chose to reclassify the shares (essentially taking the company private).

So What?

And almost as briefly, here are some of the reasons the opinion matters:

1.  Independence Is Based on the Facts. The decision makes clear that the Delaware courts will closely examine the facts and not only the form of the actions by the directors.   In this case, that close scrutiny arose with the court’s examination of the basis for certain directors to claim independence.   (They found that independence was not supported by the facts.)   The good news is that a decision on a transaction can be defended if board independence withstands scrutiny.

2.  The Business Judgment Rule Applies. The standard for review is the “Business Judgment Rule,” rather than the more stringent Unocal standard. Unocal applies only when a board engages in “defensive” actions and this one was not a defensive action.  As the court said, under the Business Judgment Rule “[. . .] the board is entitled to a strong presumption in its favor, because implicit in the board’s statutory authority to propose a merger, is also the power to decline to do so.”  This lower standard will apply only if the assertions of disinterest and independence of the board members can be supported by the facts.

3.   Officers Are on the Hook, too. Put simply, officers of Delaware corporations have the same fiduciary duties as do directors.  This is quite significant.

4. “Careful Deliberation” Means Just That. The proxy statement issued for the transaction stated that the board had carefully deliberated on the possible merger but the court looked closely (again, those pesky facts) and found that this was simply not so.   Saying it was so just made it worse.   This meant that the defense of shareholder ratification collapsed because the shareholders who approved it were not adequately informed.

The Juicy Bits.

This is not the place to analyze the opinion in detail (after all, these are called “QuickBlasts” for a reason).    So, we’ll make a few more comments and keep monitoring events as they unfold. Here’s what we think is interesting.   The court determined that the Company’s inside director was not independent because he knew that at least one potential acquirer intended to replace the board members.   In addition, the court also found that two directors were not truly independent because their local businesses provided a substantial amount of services to the company.   Hence, our point about facts and the reality of “independence.”

As for the fiduciary duties of officers, Gantler is the first time that the Delaware Supreme Court has made a clear statement of this rule.  To some this comes as no surprise.   But, what’s troubling is that officers do not have the protection under Delaware statute granted to directors.  This could get a bit dicey.   Nonetheless, officers now need to understand such principles as conflicts of interest and the duty of loyalty.   Some of us would say, well, it’s about time.

Closing Comments.

One could say that Gantler represents the Delaware courts again reminding the corporate world about reality, especially in corporate governance—i.e., independence—but also, this time, the fiduciary duties of the officers.   In other words, the courts there understand that officers wield a lot of influence while also, potentially, being subject to all sorts of “temptations” that directors cannot consider.   Now, essentially, everyone who runs a company—officers and directors alike—are judged by the same standards.   Not bad for a day’s work of the Delaware Supreme Court.

James C. Roberts III, Esq.

jcrext@globalcaplaw.com

http://www.globalcaplaw.com