Five Delaware Law Developments for Venture-Backed Companies in 2020
The first quarter of 2020 has brought interesting Delaware law developments for private, venture-backed companies. As is often the case, arising issues for companies in the venture capital and private equity space have had a different emphasis from the public company area. While public companies may be considering issues such as “virtual” stockholder meetings, delayed dividends and MACs in merger agreements, we have identified five main Delaware law highlights below in the VC/PE space.
1. Pay to play financings
Companies are exploring more aggressive structures and conversion multiples. This includes departures from the NVCA model approach including, in some instances, “pull up” for the participating preferred only without conversion of the non-participating preferred to common, exceptions for (or targeting of) certain holders, and defining pro rata participation based on money in rather than share count. The combination of lower valuations, insider participation, and more aggressive structures may increase the risk of challenge. One recent Delaware case shed light on potential fiduciary claims and defenses in such circumstances, including addressing the extent to which a pro rata “rights offering” will insulate a transaction from challenge. Strategic Value Opp. Fund v. Permian Tank, C.A. No. 2018-0932-AGB (Del. Ch. Nov. 22, 2019) (rejecting argument that right to participate in round led by major investors eliminated fiduciary challenge by other stockholders, who might not practically have the ability to invest; also ruling that fairness and damages depended largely on the extent, if any, that the transaction price and terms differed from arm’s length, “market” in the circumstances).
2. Improper use of blocking rights
As companies in distress seek financing, boards and investors should be aware of recent cases allowing liability claims to proceed against investors alleged to have used blocking rights to force companies to forego third party offers and instead enter into allegedly unfair terms with the blocking party. See Skye Mineral Investors, LLC v. DXS Capital (U.S.) Limited, C.A. No. 2018-0059-JRS (Del. Ch. Feb. 24, 2020); Basho Technologies v. Georgetown Basho Investors, LLC, C.A. No. 11802-VCL (Del. Ch. July 6, 2018). In neither case, nor in Permian Tank, was an independent committee used to consider the transaction and mitigate potential liability.
3. Corporate governance when all directors not available and use “e-notices”/ “e-signatures”
Private company boards often take action by unanimous consent. Under Delaware law, that requires consent from all directors, regardless of whether they are able to act or are reachable (or have a conflict). However, there are ways to make board action easier, including consents by email without signature (or by “DocuSign” or similar technologies); use of a committee possessing the day to day authority of the board; and acting via telephone board meetings and, if desired, reducing quorum to as low as one third of the full board. Adoption of an “emergency bylaw” under section 110 of the DGCL, which allows the quorum to be the number of directors actually available and allows officers to fill in for absent directors, may also provide flexibility in the current environment.
Similarly, in the current “remote” environment, practitioners in the VC/PE space should remember that key parts of the 2019 amendments to the DGCL further enabled corporate actions through electronic means in two main respects: (i) for purposes of Delaware law, corporate notices provided to stockholders may, as a default rule, now generally be provided by email (without, as was previously required, the stockholder first consenting to receiving notices by email) and (ii) the DGCL now includes a “safe harbor” to allow most corporate acts and transactions to be effected through “DocuSign” or other similar electronic means.
4. Forum selection
Forum selection charter provisions requiring federal securities law claims to be brought in federal court were recently recognized as facially valid by the Delaware Supreme Court. Salzburg v. Blue Apron Holdings, No. 346, 2019 (Del. Supreme Mar. 18, 2020). This may become a standard provision in pre-IPO charters and bylaws. It’s also a reminder of the settled validity and usefulness of a Delaware exclusive forum provision for fiduciary suits and claims relating to a Delaware corporation’s governing documents (including standard “private company” documents such as a stock purchase agreement, investor rights agreement or voting agreement). Fast resolution by the Delaware Chancery of Court — with no jury, no punitive damages, and before a judge with deep expertise in corporate law — may benefit companies contemplating challenging financings and transactions. Often a forum selection bylaw could be adopted solely by a board resolution prior to such a transaction.
5. Director liability for “failure to monitor”
Recent cases have allowed personal liability claims to proceed against boards for failing to have in place controls for monitoring, or failing to respond to clear warning signs concerning, “mission critical” compliance and business issues (for example, consumer safety for a food company, FDA clinical trials for a drug development company, and pipeline integrity for an energy company). Marchand v. Barnhill, 2019 WL 2509617 (Del. Supreme June 19, 2019); In re Clovis Oncology, 2019 WL 4850188 (Del. Ch. Oct. 1, 2019); Inter-Marketing Group USA, Inc. v. Armstrong, C.A. No. 2017-0030-TMR (Del. Ch. Jan. 31, 2020). A key factor in these cases was the lack of a clear, board-level reporting system and an insufficient record of director consideration of the issues. These concerns may have particular application in the private company context, where control systems may be less developed.
Should you have any questions or need advice regarding potential Delaware law issues relating to private, venture-backed companies, please contact Jeff Wolters, Dan Matthews or any member of Morris Nichols’ Corporate Law Counseling Group.
Copyright © Morris, Nichols, Arsht & Tunnell LLP. These materials have been prepared solely for informational and educational purposes, do not create an attorney-client relationship with the author(s) or Morris, Nichols, Arsht & Tunnell LLP, and should not be used as a substitute for legal counseling in specific situations. These materials reflect only the personal views of the author(s) and are not necessarily the views of Morris, Nichols, Arsht & Tunnell LLP or its clients.
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