IN THE COURT OF CHANCERY OF THE STATE OF DELAM’ARE
IN AND FOR NEW CASTLE COUNTY
BERNARD B. FULK, III,
>
1
Plaintiffs,
)
>
V.
C.A. No. 17747-NC
>
1
WASHINGTON SERVICE
ASSOCIATES, INC. and THE
LAURENCE J. LONG FAMILY
TRUST II,
Defendants.
1
>
)
>
)
>
OPINION
Date Submitted: May lo,2002
Date Decided:
June 2 1.2002
Daniel A. Dreisbach, Esquire of RICHARDS LAYTON & FINGER, P.A.,
Wilmington, Delaware; and Allen S. Rugg and Bart T. Valad, Esquires of
POWELL, GOLDSTEIN, FRAZER & MURPHY, LLP, Washington, D.C.;
Attorneys for the Plaintiffs.
Michael D. Goldman, Kevin R. Shannon, and Richard L. Renck, Esquires of
POTTER ANDERSON‘ & CORROON, LLP, Wilmington, Delaware;
Attorneys for the Defendants.
Bruce L. Silverstein, Esquire of YOUNG, CONAWAY, STARGATT &
TAYLOR, Wilmington, Delaware; Attorney for Martin G. Mand, Custodian.
JACOBS, VICE CHANCELLOR
Bernard B. Fulk, III (“Fulk”), who is a 50% shareholder of
Washington Services, Inc. (“WSA” or the “Company”), brought this
proceeding against WSA and its other 50% shareholder, Laurence J. Long,
(“Long”), seeking the dissolution of WSA under 8 Del. C. 8 273 and the
appointment of a custodian under 8 Del. C. $ 226. Thereafter, by agreement
of the parties, the Laurence J. Long Family Trust II (the “Trust”), to which
Mr. Long had later transferred his WSA stock, was substituted as a
defendant for Long. A two day trial was held in February 200 1.
At post-trial oral argument, which took place in June, 2001, the Court
determined to appoint a Receiver with custodial powers to conduct the sale
of WSA. By Order dated June 20,2001, the Court appointed Mr. Martin G.
Mand as Receiver/Custodian (the “Custodian”). The Custodian was directed
to formulate and execute a Plan of Sale that would maximize the value to the
shareholders in a judicially ordered sale of WSA.
The Custodian interviewed the parties and other key WSA employees
and witnesses, conducted a comprehensive review of WSA and its
operations, and attempted (without success), to mediate the parties’ dispute.
On October 26, 2001, the Custodian issued his Report (the “Report”) in
which he recommended a comprehensive Plan of Sale of WSA that would
impose certain conditions which, the Custodian concluded, were essential to
maximize value for both WSA shareholders.
Pending is a motion by Fulk, as plaintiff, to approve the Report of the
Custodian. Long and the Trust,’ through their original counsel of record,
opposed the approval of the Report on various grounds. Thereafter, the
Long interests obtained new counsel who interposed additional objections,
which led to supplemental briefing that protracted the proceeding by several
months.
This is the Opinion of the Court addressing the merits of the
Custodian’s Report 2 and all objections to it. For the reasons next discussed,
the Court concludes that the Report and the recommendations contained
therein will be approved.
I.
THE FACTS
What follows are the pertinent facts. Many facts are undisputed, but
where there are disputes the facts are as found herein.
A.
The Parties
WSA, a Delaware joint venture corporation that maintains its
’ Unless the context indicates otherwise, Mr. Long, the Trust and the Long children who
are trustees of the Trust and/or employees of WSA are referred to collectively as “Long”
or the “Long interests.*’
* After the Long interests advanced their “first round” of objections, the Custodian issued
a Supplemental Report on December 13,2001, in which he modified one of his
recommendations. Except where otherwise noted, all references in this Opinion to the
Custodian’s “Report” include both the original and the Supplemental Report.
.
.
principal office in Washington, D.C., is in the business of reporting and
analyzing various governmental policies and other infomlation
institutional investors3
for
WSA has two 50% stockholders. The original
shareholders were Messrs. Fulk and Long, but Long later transferred his
50% interest to the Trust. Since August 1992, Messrs. Fulk and Long have
been the Company’s two directors, with Long serving as WSA’s President
and Chief Executive Officer, and Fulk serving as WSA’s Secretary and
Treasurer.
Besides Messrs. Fulk and Long, the Company has eight employees.
Two of those employees are Long’s children, Timothy and Christopher. A
third employee, Jeff Cahill, is the Company’s bookkeeper, accountant, and
financial advisor. Cahill is also a friend of the Long family and an adviser to
Long in this litigation. At all relevant times Long has been in operational
control of the business. The full-time employees of the business are loyal
exclusively to Long-a fact whose relevance will soon appear.
WSA has consistently been profitable and has achieved attractive
margins and a solid record of generating cash without incurring any debt.4
3. WSA was incorporated in Delaware in 1988 after Messrs. Long and Fulk purchased it
f?om Legg Mason.
4 WSA has not, however, delivered any sustainable growth in either revenue or net
income during the five years preceding the Custodian’s appointment.
3
During the last five years, Long received compensation equal to 60% of the
Company’s net income (i.e., income after all expenses before any payments
to stockholders). Fulk has received the remaining 40%.’
B.
Background of The Dispute
During the late 199Os, the relationship between Messrs. Fulk and
Long began to deteriorate. Although the precise reasons are not altogether
clear, it appears that the parties’ dispute originated in Long’s belief that he
and his sons had contributed a disproportionate share of the Company’s
value, in contrast to Fulk, whose contribution (in Long’s estimation) was far
less. Beginning in 1998, Long and Fulk had numerous discussions about
either Long or the Company buying out Fulk’s interest in WSA. The two
founders, however, were unable to reach an agreement on the purchase
price.
In 1998, a firm called IBC Group, plc. (“IBC”) offered to acquire
WSA for $16 million. IBC’s proposal was agreeable to Fulk, but Long
rejected it because he (Long) wanted to continue operating WSA and also
wanted WSA to become a Long family-owned enterprise. Accordingly,
Long proposed to buy Fulk’s 50% interest for $5 million, net of all resulting
taxes, to be paid out of WSA’s future profits. That proposal went nowhere,
’ In 2000, Long took out $994,000 from WSA, and Fulk took out $668,000.
however, because Long soon withdrew it at the behest of his children who
were both employees of WSA and beneficiaries of the Trust.
Long’s
children complained that $5 million was too much to pay Mr. Fulk who, they
believed, had contributed very little to the value of the enterprise.6
Thereafter, Long told Fulk that he no longer wanted to remain in
business with him. Long also informed Fulk that he was disappointed in
Fulk’s performance and that he intended to reduce his salary. From that
point on, the parties’ relationship deteriorated further and led ultimately to
this Delaware proceeding, as well as litigation between the parties in
Washington, D.C. What prompted this Delaware lawsuit was that beginning
in the Spring of 2000 and continuing to the present, Long has objected to,
and obstructed, every effort and proposal Fulk has made to assure that WSA
would be sold at a fair market price. A recital of Long’s conduct, which
next follows, evidences a consistent pattern in that regard.
6 In his deposition taken in an action that Long filed in the District of Columbia, Long
testified that “two of my children, the two youngest children, who work in the security
business, came to me-and both of them have worked in the business with me-and said
‘Dad, why are you doing this? This is entirely too much money to be giving to Mr. Fulk.
Mr. Fulk has done very little to contribute to the value in the corporation.” June 2,200O
Deposition of Laurence J. Long, Long v. Fulk, D.C. Super. Ct., CA. 99-8974, at 111. Mr.
Long has acknowledged that he desires to consolidate ownership of WSA in his family.
Id. at 73.
c.
Long’s Efforts To Frustrate A Sale
Of WSA At A Fair Market Price
In the Spring of 2000, Fulk contacted several investment bankers with
a view towards retaining one of them to locate a buyer for WSA. Those
bankers later met with Long, who told them that he and WSA’s other
employees intended to form their own company to compete with WSA
immediately after WSA was sold. Believing that Long’s announced plan
would likely chill any bids for the Company at a fair market price, the
bankers quickly lost interest in being retained.
There has also been a second obstacle to a sale of the Company (to
Fulk or to an outside third party) at a fair market price-Long and the
employees loyal to him are the sole repositories of the technical knowledge
about WSA’s computers and their information processing software
programs.
That technical software information is not documented in any
manual, booklet, file or other record maintained by the Company. The
information is critical to any prospective buyer, because it is essential to
WSA’s operations. Were Long and the current key employees to compete
with WSA post-sale, that would leave any purchaser of WSA at an
enormous disadvantage, because the absence of technical computer software
information would. severely disrupt the continuity of WSA’s operations.
That disadvantage would cause a potential purchaser to decide either not to
6
acquire WSA at all, or to acquire it at a significant discount from fair market
value.
Mindful of this problem, in 2000 and 2001, Fulk advanced several
proposals in an effort to secure the continuity of operations post-sale. Fulk
proposed hiring additional computer personnel not aligned with the Longs,
or, alternatively, retaining the services of a computer consulting firm to
determine the nature of WSA’s critical software and then reducing that
information to “operating manual” form that would be accessible to any
purchaser of WSA. Long, as the Company’s CEO, unilaterally rejected
Fulk’s proposals.
Moreover, during the trial both Long and the Trust
opposed the retention of a computer consulting firm, which up to that point
had been the cornerstone of Fulk’s proposed Plan of Dissolution.
In December 2000, Long learned that Informa Financial Information,
Inc. (“Informa”), a firm that had acquired IBC, was interested in possibly
renewing IBC’s offer to purchase WSA.7 At Mr. Long’s instruction, Jeff
Cahill, WSA’s accountant, called Informa’s CEO and told him that all of
WSA’s employees would leave WSA if the Company were sold to Informa.
Not surprisingly, Infonna made no offer to acquire WSA.
7 KBC’s 1998 offer was for $16 million.
In a further effort to resolve the dispute, the Court, at the conclusion
of the trial, proposed that the parties consider having the Company valued by
a financial expert, based upon the assumption that the existing key computer
personnel would remain with the Company after the sale. After the
Company was valued, Messrs. Long and Fulk would be allowed to bid for it,
with the expert’s valuation being the floor price.
Long rejected that
proposal, asserting that he would not bid unless the valuation were based on
the assumption that after that sale, Long and his son, Timothy Long, would
leave WSA and set up a competing business.’
After his appointment, the Custodian also attempted, without success,
to mediate the parties’ dispute. During the mediation the Trust, represented
by Christopher Long, offered to pay $1.5 million for Fulk’s 50% interest in
WSA, subject to certain terms and conditions. Fulk offered to purchase the
Trust’s 50% interest for $2.3 million, also subject to certain terms and
conditions. When asked to explain why the Trust’s offering price was less
than Fulk’s, Christopher Long responded that the Trust did not wish to pay
for his father’s past (and presumably future) contributions to WSA’s
business. The Custodian disagreed with this reasoning, stating in his Report
that “Chris Long’s father’s very significant contributions to WSA are now
* Def. Post-Hearing Brief at 40.
proprietary technology was part of the business and owned by both
stockholders.” 9
The foregoing background, plus the other knowledge he developed
while familiarizing himself with this case, prompted the Custodian to
observe that:
[rleasonable people, of course, can have different
opinions as to the value of a given asset. In this
particular case, Long’s competitive threat, and the
potential loss of other key employees (Cahill; Tim
Long; Richard Dann and Chris Dann), as well as
the technology documentation issue, all exasperate
[exacerbate] what would normally be a simple
difference of viewpoints. It is clear to the
Custodian that it will be very difficult for any
outside third-party to “get its arms around” the
value of WSA, and, thus, may decline to
participate in a bidding process.”
The Long interests’ course of conduct (and the conduct of the
employees loyal to them) after the Custodian’s appointment, further
illuminates the Custodian’s “exasperat[ion].” On August 10, 2001, the
Custodian received an unsolicited letter, signed by four WSA employees,
stating in what amounted to an ultimatum, the only terms on which those
employees would cooperate with the Custodian’s efforts to secure
9 Custodian’s Report at 16 (emphasis added).
continuity. The employees demanded an additional bonus in return for their
cooperation.
They also asserted that “[w]e have agreed that we will not
offer such continuity assurances on an individual basis.“” The Custodian
believes (as does the Court) that this unsolicited letter was “a direct result of
the Custodian’s conversation with Long and Chris Long on August 8, 2001
regarding the draft terms and conditions of a buy-out agreement [that] the
Custodian [had] proposed on that date.“”
On August 13, 2001, the Custodian received a second unsolicited
letter, this time from Long.
Several days earlier, Long learned that the
Custodian had decided to hire a computer documentation expert. In his
August 13, 200 1 letter, Long asked the Custodian to postpone hiring that
expert, warning that “[a] number of the key employees have informed me
that they will refuse to cooperate in this [computer] documentation effort
and will leave the firm rather than do it.“13
In his Report, the Custodian concluded that Long’s actions (including
his threats) while still the CEO of WSA, to leave and compete with the
company, created a potential conflict of interest:
lo Id.
” Custodian’s Report, Ex. 2.
l2 Custodian’s Report at 6.
l3 Id; Custodian’s Report, Ex. 3.
10
In view of Long’s stated intent to leave WSA and
to compete with WSA if the Trust does not acquire
Fulk’s interest in WSA, and [in view of] the stated
intent of several key people to join Long in
competition with WSA, there is, at least, the
appearance of a potential conflict of interest with
Long’s fiduciary responsibilities as a director and
officer of WSA. . . . Plainly, however, Long is in a
position to take actions that would lower the value
of WSA-rather than maximize it-in the event of
a sale to anyone other than the Trust.14
The Custodian also expressed his “disappoint[ment] that Long, as the
CEO, despite his leadership abilities, has not been able to convince WSA’s
technology employees to be more cooperative with the sale process for the
benefit of all stockholders.“‘5
The competitive threat posed by Long and the key WSA employees
also prompted the Custodian to express the following concerns:
The Custodian is concerned about the impact on
WSA’s value by Long’s competitive threat and the
probability that many, if not all, key employees
will leave with Long if he sets up a competing
business. The Custodian also is concerned because
he understands that Long has long-time personal
relationships with many of WSA’s largest clients.
These issues will, no doubt, scare off most, if not
all, potential third-party buyers and further create
the need for any potential buyer to fill key
positions, including the CEO, with qualified
people. In other words, such a buyer not only has
I4 Custodian’s Report .at 9.
” Id. at 14.
to compete with a very competent competitor, but
has lost for some period of time, at least, the
personnel resources to compete. This makes it
likely that there will be few outside buyers, if any,
and, thus, lowers the value of WSA.
However, the threats would seem to work to the
benefit of the Trust if it is the buyer in two ways:
(1) the Trust does not need to be concerned with
these competitive threats, as Long and key
employees will not only not leave WSA and
compete, but they and the clients will remain and
WSA will be able to operate “without missing a
beat,” and ([2]) the Trust would be able to acquire
a “going concern” without having to pay a “going
concern” value.
This situation provides the Trust with a
“negotiating advantage.“‘6
D.
The Custodian’s Proposed Plan
Of Sale And The Objections To It
1.
The Custodian’s Recommendations
These problems and his discussions with outside professional advisers
led the Custodian to conclude, in his business judgment, that a sale to an
outside third party would be unlikely and, moreover, that any bids by
outsiders would probably be less than what either of the current stockholders
would be willing to pay. Accordingly, the Custodian concluded that value
l6 Custodian’s Report at 11-12.
12
would be maximized in a sale of WA to either of the two stockholders, but
not in a public auction.
The Custodian therefore recommended that the Court order a
purchase/sale process involving only the two stockholders, Fulk and Long,
by one of three methods. Under “Method One,” one of the two stockholders
(the “offeror” stockholder) would offer to purchase or sell his (or its) interest
for a stated price. The other (“offeree”) stockholder would then decide
whether to buy or sell his (or its) interest at the price established by the
offeror stockholder.
The Custodian recommended Method One as his
preferred approach, with the Trust being the offeror-stockholder and Fulk
being the offeree, who would have the option to buy or sell at the price
established by the Trust.17
Although both sides agree that this proposed Plan of Sale will most
likely maximize value, each side has raised certain objections, and has
l7 Under “Method Two,” each stockholder would submit to the Custodian a single price
at which the stockholder would be willing either to buy or sell his (or its) interest. The
stockholder submitting the lower price would then decide whether to buy at the higher
price, or to sell its interest at the higher price submitted by the other stockholder.
Under “Method Three,” both stockholders would bid to purchase one share of WSA’s
authorized, but unissued, stock. The higher bidder would purchase the one share, which
would give that stockholder majority voting control, and the minority stockholder would
have whatever rights are permitted under the law. Because both sides agree that the
Custodian’s proposed Plan of Sale (Method One) is the approach that most likely will
maximize value for both shareholders, it is unnecessary to (and the Court does not)
address Methods Two or Three.
proposed certain modifications, to this proposal that the other side opposes.
Because those objections frame the issues that must be resolved in this
Opinion, it is helpfil to describe those controverted features of the proposed
Plan of Sale.
2.
The Parties’ Objections
Most stridently controverted is the Custodian’s proposal that “[tlhe
seller, and persons aligned with the seller, should be enjoined from taking
certain actions inimical to the best interests of WSA and the buyer, and
which would, in any event, constitute a breach of fiduciary duty to WSA and
the buyer if undertaken.” In particular, the Custodian proposes that if the
Trust is the purchaser, then Fulk, any of his family members, and any
entities in which he has a significant financial interest, would be enjoined for
180. days following the Closing Date, from (i) soliciting any current
employee of WSA, and (ii) soliciting any current client of WSA or any past
client of WSA who has - paid any invoice to WSA during the year prior to the
Closing Date.
Similarly, if Fulk is the purchaser, then the Trust, Long, any of Long’s
family members and any entity in which Long or the Trust has a significant
financial interest would be enjoined for 180 days following the Closing date
from (i) soliciting any current employee of WSA, and (ii) soliciting any
current client of WSA or any past client of WSA who has paid any invoice
to WSA during the year prior to the Closing Date.
In addition, irrespective of who winds up as the purchaser, all
directors, officers, employees and agents of WSA would be enjoined from
(i) removing and/or retaining any copies of WSA’s proprietary information
and/or corporate assets, including but not limited to WSA’s files, documents,
programs, systems and customer lists; and from (ii) utilizing WSA’s
proprietary information and other corporate assets for the benefit of anyone
other than WSA. l8
Long endorses the Custodian’s Plan except for its injunctive
provisions. Long’s former counsel advanced a host of objections, and his
new counsel then advanced additional objections, to those provisions. Fulk
supports the Custodian’s proposed Plan for the sale of WSA, including its
injunctive provisions, which he contends are entirely appropriate and fall
within the scope of this Court’s powers under 8 Del. C. 5 273. Fulk claims,
however, that the Custodian must impose further additional “closing
conditions.“‘g
” These proposed restraints are collectively referred to as the “injunctive provisions.”
l9 Both Long and the Custodian agree in principle to the need for closing conditions, but
not to all of the specific conditions Fulk proposes. Because the Custodian is willing to
negotiate closing conditions with both sides, and requests that the Court grant him the
authority (after consulting with the parties) to establish closing terms and conditions, the
15
II.
A.
ANALYSIS OF THE OBJECTIONS
TO THE CUSTODIAN’S PLAN TO
MAXIMIZE VALUE IN A SALE
OF WSA UNDER 8 DEL. C. 5 273
The Issues In Perspective
And The Contentions
1.
The Perspective
The parties’ contentions and the issues that flow from them are best
understood when viewed in context.
Accordingly, that context is first
summarized.
The core of the problem is that although WSA is a joint venture
corporation with two 50% stockholders, WSA’s owners never agreed to an
“exit strategy” to recover the value of their investment in the event the joint
venture was terminated.
In many ventures of this kind the governing
Court will not address the merits of the proposed closing conditions inthis Opinion. It
will, however, authorize the Custodian to approve any agreement of purchase or sale
reached by the parties, including any conditions of closing.
Both Long and Fulk ask that the Custodian’s proposed Plan be modified to require
that the promissory note given by the purchaser be collateralized. Thereafter, new
counsel for Long took the inconsistent position that the underlying requirement of a
promissory note is an unreasonable condition altogether. In response, the Custodian
agreed to modify his proposed Plan to require that the purchaser pledge 100% of the
shares of WSA as collateral for the promissory note. This requirement would prohibit the
purchaser from selling WSA after the purchase, unless the promissory note were paid in
full or acceptable alternative collateral were provided. That requirement would also deter
any purchaser from devaluing WSA (whose stock is the collateral) by competing with it.
Because this proposed modification of the Custodian’s Plan is reasonable, the Court
approves it.
instruments create an exit strategy, which typically takes the foml of a “buy
out” by one stockholder of the other’s interest. In some cases the buy out
price is either an agreed-upon dollar amount, a formula by which the price
can be calculated, or a procedure or process by which the buy out price can
be determined (for example, arbitration). Unfortunately, in this case, when
WSA was formed its governing instruments did not set forth an agreed buy
out price, formula or process. Moreover, the stockholders were unable to
reach agreement on that critical issue.
In those circumstances the only
alternative was to resort to the “default rules” afforded by the pertinent
Delaware statutory and case law. This proceeding under 8 Del. C. §$ 226
and 273 was the result.
Originally, Fulk, as plaintiff, advocated that the Court should approve
a plan that involved selling the Company’s assets (as distinguished from its
stock) to a third party.*’ The stumbling block was (and still is) that no third
party will pay a fair market price for WSA, absent assurances of immediate
access to the proprietary computer software that is so integral to the business
being acquired. Unfortunately, no such assurances could be given, because
no documentation exists that would enable an acquirer of WSA,
*’ Specifically, WSA’& business, including its proprietary computer software and its
existing arrangements with clients.
immediately upon taking control, to operate the computer software. Under
Long’s management, no such documentation was ever created. Instead, the
technical “know how” relating to that computer software was allowed to
remain in the “heads” of WSA’s key employees, including Long, who is
unwilling for WSA to pay to solve the documentation problem that occurred
on his watch. If Long and the key employees form their own competing
company post-sale as they have threatened to do, that would enable them to
divert WSA’s critical proprietary software to themselves, leaving any buyer
of WSA in the position of acquiring a business without the computer
software information that is needed for its operation.
To solve this problem, Fulk urged the Court to appoint, at the
Company’s expense, an independent computer consulting firm (specifically,
Marasco-Newton) to document all of WSA’s proprietary software. The
Long interests opposed that request, claiming that as a business matter the
cost of the documentation would exceed any benefit.
The result was a two-day trial on whether the Court should order
software documentation. The evidence presented at that trial led the Court
to conclude that the larger question-how best to maximize value for the
shareholders in a sale of the Company-involved several alternatives, of
which creating software documentation was only one.
Deciding which
alternative was the best would require weighing several complex business
considerations-a task that a person with a business background could
perform far more competently than this Court. Accordingly, the Court
appointed the Receiver/Custodian, who recommended that WSA be sold to
one of its shareholders on terms that include the injunctive provisions at
issue in this proceeding.
Although in form those injunctive provisions would apply to
whichever of the two stockholders ends up as the seller, in substance and in
practical terms the injunction would benefit only Fulk, but would afford no
significant benefit to Long. As the buyer, Long would receive little benefit
from the injunction because the Long interests already have operational
control of the Company, including its customer relationships and its
computer software, and there is no evidence that after the sale Fulk is
yearning to form a company to compete with a Long-owned WSA. But, if
Fulk were the buyer, he would be significantly and adversely affected,
unless the injunctive provisions were imposed, because after the sale the
Long interests will form a company to compete against a Fulk-owned WSA.
In that endeavor, Long would have a competitive advantage, because the
Long interests already have both exclusive access to and control of
customer-specific information, and exclusive knowledge of WSA’s
computer software. By preventing the Long interests from soliciting WSA’s
customers and from using that confidential proprietary information for six
months after the sale, the Plan’s injunctive terms would remove that
competitive advantage, and to that extent would adversely affect Long.
But upon further reflection, it is clear that the injunctive provisions
would adversely affect Long onZy if Long has been unwilling to pay a fair
price for Fulk’s interest in the Company. The reason is not complex. Under
the Custodian’s Plan of Sale, if Long offers a fair price for Fulk’s 50%
interest, then Fulk will sell to Long; if, however, Long is unwilling to offer a
fair price, then Fulk will not sell but would become the buyer. Thus, to
avoid the adverse impact of the proposed injunctive terms, all Long need do
is offer a fair price that Fulk is willing to accept.
In short, the entire thrust of the proposed injunctive provisions is to
induce Long-who desires to be the sole owner of the Company-to pay a
_
fair price for the 50% equity interest owned by Fulk. But, paying a price
that is acceptable to Fulk is something that Long is unwilling to do and has
mightily resisted doing all along. Long’s strategy has been to block Fulk
from having any legal or practical alternatives, so that Fulk would have only
one choice:
accept whatever price for his ownership interest-however
20
inadequate--that Long is willing to pay. Consistent with that strategy, Long
has opposed the injunctive provisions by unleashing a torrent of
hypertechnical arguments. Those arguments have not the slightest equity.
Indeed, they are designed to persuade me that as a legal matter, the Court of
Chancery has no alternative other than to reject the Plan’s injunctive
provisions that would prevent Long from acquiring 100% ownership of
WSA as a going concern without having to pay going concern value.
The context having been described, the Court next summarizes, and
then addresses, Long’s contentions.
2.
The Contentions And The Issues
Despite their multitude, Long’s arguments are reducible to three sets
of contentions. The first is that under Section 273 this Court lacks any
power to order a sale of one 50% stockholder’s interest in the corporation to
the other 50% owner (as the Custodian here proposes), unless both
shareholders agree to all the terms of that sale. Long argues that because the
corporation’s two stockholders are unable to agree upon the terms, the
statute precludes any remedy other than a court-ordered dissolution and
winding up of the corporation, in which the stockholders would have no
right to have the corporation sold as a going concern.
21
.
Long’s second group of arguments boils down to the position that
even if the Court is empowered to order a sale of one 50% stockholder’s
interest to the other under terms not agreed to by both, Section 273 deprives
the Court of the power to order the kind of injunctive restraints being
proposed here. That is so, Long contends, for three reasons: (i) a Section
273 proceeding is in rem and by its very nature bars the grant of an
injunctive restraint that would operate in personam against persons who are
not parties before the Court (i.e., the Longs and WSA’s other employees);
(ii) whatever power this Court may have under Section 273 to maximize
value is subordinate to, and superseded by, a former corporate fiduciary’s
legal entitlement to compete, or to use confidential corporate information,
where the fiduciary is no longer a corporate employee and the corporate
employer will be dissolved; and (iii) Long and his employees cannot be
restrained from soliciting WSA’s current (or former) customers or from
using WSA’s proprietary software as part of a dissolution sale, because
neither the identity of those customers nor the software constitutes a legally
protectible trade secret.
Long’s third contention is that even if the Court is legally empowered
to direct a sale of one 50% owner’s shares to the other on the terms the
22
.
Custodian is proposing, the proposed injunctive conditions must be rejected
because they are not reasonable.
These colliding sets of contentions generate the following issues that
this Court must decide. The first is structural: is this Court empowered
under Section 273 to approve a Plan that involves a sale by one 50%
shareholder of his stock interest to the other, on terms that are not mutually
agreed to? Embedded in and pivotal to that question is a predicate issue,
namely, if both shareholders cannot agree on the terms of a stock sale, is the
Court statutorily required to order a liquidation of the corporation’s assets on
terms likely to yield a price below the corporation’s going concern value?
As discussed below, I conclude that nothing in Section 273 requires the
Court to order such a sale on such terms, or prevents the Court from
approving a sale of one 50% owner’s interest to the other where the
stockholders cannot agree on all the transaction conditions.
The second issue is whether this Court is legally precluded from
approving a Plan of Sale that includes the specific injunctive restraints
proposed here. That issue breaks down to three subsidiary questions. The
first is whether the in rem character of a Section 273 proceeding deprives the
Court of power to impose injunctive restraints that would operate in
personam against persons who are not formal parties to this proceeding. The
second is if the Court has such power, does the right of former corporate
fiduciaries to compete against, or to use confidential corporation belonging
to, the corporation when the former fiduciary is no longer an employee,
supersede or override this Court’s power to maximize the corporation’s
value in a sale under Section 273? The third subsidiary question is whether
even if the fiduciary’s right to compete does not have that overriding effect,
the Plan’s injunctive provisions are nonetheless legally proscribed because
the identity of WSA’s current or former customers, and WSA’s computer
software, are not trade secrets. As discussed below, I conclude that these
objections lack merit and that this Court is fully empowered to approve a
Plan of Sale that contains the injunctive provisions the Custodian is
proposing here.
The third and final issue is whether, even if the Court is empowered to
impose the injunctive and other conditions of the proposed Plan of Sale,
those controverted conditions are reasonable. For the reasons discussed
below, I conclude that they are.
B.
The Structural Issue
Long first contends that Section 273 prohibits a court-ordered sale of
the ownership interest of one 50% shareholder to the other, where the two
owners do not agree on all of the post-sale terms being proposed. Long
argues that as a purely structural matter Section 273 proscribes such a sale,
because the statute provides that “if no such plan [to discontinue the joint
venture and to dispose of the assets used in such venture] shall be agreed
upon by both stockholders, ” the petition must state that the petitioner desires
that “the corporation be dissolved.“*’ Long also points to statutory language
which provides that unless both stockholders, within three months of the
filing of the petition, file a certificate stating that they have agreed on a plan,
“the Court of Chancery may dissolve such corporation and may by
appointment of 1 or more trustees or receivers . . . administer and wind up its
affairs.“**
From this language Long argues that in these circumstances, (i) the
Court’s power under Section 273 is limited to dissolving the corporation and
appointing a trustee or receiver; and (ii) the power of the trustee or receiver
is limited to selling the corporation’s assets (as distinguished from selling
the stock interest of one stockholder to the other); and (iii) because the
corporation will be discontinued, Section 273 does not require that the sale
capture the corporation’s “going concern” value.
discussed, these arguments have no merit.
*’ 8 Del. C. $ 273(a).
** 8 Del. C. $ 273(b).
For the reasons next
First, Long’s argument finds no support in Section 273. Long’s
position presupposes that absent a plan that is agreed to by all the
corporation’s stockholders, the statute mandates that the corporation be
dissolved and that its assets be sold, either as a collective or on a piecemeal
basis, but not configured as an ongoing business at going concern value.
The problem is that no such mandate appears from even a cursory reading of
Section 273.
The statute does not require the Court to dissolve the corporation.
Rather, Section 273 provides that the Court “may dissolve such corporation
and may by appointment of 1 or more trustees or receivers. . . . administer
and wind up its affairs.“23
Nothing in the statute requires that process to be
contorted into a procedural straightjacket that limits the Court to only one
structure for discontinuing a joint venture in the absence of an agreed-upon
plan. To the contrary, the statute permits the Court flexibility in deciding
how the joint venture should be discontinued. As this Court held in In re
Arthur Treacher 3 Fish & Chips of Ft. Lauderdale, Inc.:
[I]n matters brought under the provisions of
Section 273, . . . the Court is not powerless to take
positive action because the statute specifically
provides that in the even certain contingencies do
not take place “* * * the Court of Chancery may
23 Id. (emphasis added).
dissolve such corporation and may * * *
The
administer and wind up its affairs.”
Legislature’s use of the word “may” was not
intended to be granted automatically upon the
filing of a petition for dissolution but rather that
the granting of such forrn of relief is
discretionary.24
The suggestion is also fully consistent with, and underscored by, 8
Del. C. $ 283, which provides that:
The Court of Chancery shall have jurisdiction of
any application prescribed in this subchapter and
of all questions arising in the proceedings thereon,
and may make such osders and decrees and issue
injunctions therein as justice and equity shall
require.
25
Second, nowhere does the statute require that a sale under Section 273
must take the forrn of a piecemeal sale of the corporation’s assets. Although
Section 273 permits such a sale, its language is equally consistent with a
court-ordered sale of the entire business to a third party as a going concern.
In different circumstances that latter approach would be an appropriate way
to discontinue WSA. _ Regrettably, however, Long’s conduct has been
calculated to-and most likely would-prevent any sale on terms that could
24 386 A.2d 1162, 1166 (Del. Ch. 1978) (internal citations omitted).
*’ 8 Del. C. 6 283 (emphasis added). Section 283, by its terms, governs any application
prescribed “in this subchapter”(referring to Subchapter X), which comprises Sections 271
through 285, inclusive. Therefore, Subchapter X applies to proceedings brought under
Section 273.
generate a fair market price (going concern value) for WSA. Long’s
conduct has led the Custodian to conclude (and this Court to find) that in
these unique circumstances the only persons who would pay a fair market
price are the two 50% owners, and that the best way to achieve that value is
to require that one 50% owner buy out the other’s interest. That structure is
the economic equivalent of a sale of the entire business in an auction in
which the two 50% owners are the only bidders. Because the statute
empowers the Court to order such a sale, surely it would also empower the
Court to order a transaction that is its economic equivalent, differing only in
form.
Third, no cited Delaware case directly or inferentially prohibits this
Court from ordering a discontinuation of a joint venture on the terms the
Custodian is proposing.
Custodian’s position.
Indeed, the case law supports Fulk’s and the
The objective of a Section 273 proceeding is to
achieve “justice and equity.“26 Consistent with that objective, in a Section
273 proceeding “a court of equity is duty-bound to protect the interests of
stockholders when they are threatened and to enforce the duties of
fiduciaries in situations in which allegations of wrongdoing are made.” 27 As
26 8 Del. C. 6 283.
” In r-e Arthur Treacher S Fish & Chips of Ft. Lauderdale, Inc., 386 A.2d at 1167.
28
joint venturers Long and Fulk owe to each other fiduciary duties of utmos1
good faith, fairness and honesty.2s Further, as WSA directors Long and Fulk
each owe fiduciary duties to the other in his capacity as a stockholder.
Those fiduciary duties include the obligation to maximize value for all
shareholders in a sale of the enterprise.2g
Those fiduciary duties do not vanish because the procedural context
happens to arise under Section 273. Those duties, moreover, are enforceable
by appropriate injunctive or other equitable processes.30
The authorities
uniformly repudiate Long’s argument that this Court is stripped of any
power to order a sale of WSA’s business on terms that will enable WSA’s
shareholders to realize its going concern value.
c.
The Injunction-Related Issues
Long next advances three arguments why this Court is legally barred
from approving a Plan of Sale that includes the injunctive restraints being
proposed here. Those arguments, in my view, have no merit either.
28 Dionisi v. DiCampZi, Del. Ch., Consol. C.A. No. 9425, Steele, V.C., mem.
(June 28,1995), amended by 1996 WL 39680 (Del. Ch.).
op.
at 18
*? Paramount Communications, Inc. v. QVC Network, Inc., 637 A. 2d 34,44 (Del. 1994);
Odyssey Partners, L.P. v. Fleming Cos., Inc., 735 A.2d 386,416 (Del. Ch. 1999).
3o 8 Del. C. fj 283; E. I. DuPont de Nemours & Co. v. Am. Potash & Chemical Corp., 200
A.2d 428,432 (Del. Ch. 1964).
Long first argues that because a Section 273 proceeding is in rem, the
Court lacks the power to impose injunctive restraints that would operate in
personam against persons who are not formal parties to this proceeding,
specifically, the Long family members and the WSA employees who are
loyal to them. This argument fails because Section 283 empowers the Court
to issue “such . . . injunctions . . . as justice and equity shall require,” and
because Court of Chancery Rule 65(d) provides that an injunction “shall be
binding . . . only upon the parties to the action, their officers, agents,
servants, employees, and attorneys, and upon those persons in active concert
with them who receive actual notice of the order by personal service or
otherwise.”
Thus, Long and members of his family who are WSA officers,
employees or agents, and the non-Long family employees of WSA who
receive the prescribed notice, will all be bound by any injunction directed
against the current parties (WSA, Fulk and the Trust). To avoid any further
issue as to whether any of those persons would be bound by an order
awarding the injunctive relief at issue in this case, the plaintiff is granted
leave to join any or all of those persons as additional parties to this
proceeding.3 ’
Long next argues that even if this Court is empowered to order a sale
of the corporation under terms that would maximize its value, in this
particular case that power is subordinate to, and superseded by, the right of
former corporate fiduciaries to compete against (or to use confidential
information belonging to) a corporation that will be dissolved and will no
longer exist. The argument is flawed in several respects. It rests on the
premise that WSA will be dissolved and will cease doing business,
but in fact that is not inevitable. Here, the interest of one of the two coowners of WSA would be sold to the other owner who, as the buyer, would
be free to continue operating that business in which WSA would continue as
an ongoing entity.
Long’s argument also unfairly distorts the commonly understood
meaning of the term “compete.” The cases that recognize the right of a
fiduciary to compete against a former corporate employer involve
circumstances where the fiduciary has placed himself at risk by first
31 Both Rule 65 and the plaintiffs ability to join Long and his family members and other
allies at WSA as parties for the limited purpose of granting complete relief, afford a
complete answer to L&g’s assertion that the injunction provisions of the Plan of Sale
would violate the Long’s (and his allies’) due process rights.
31
resigning his employment, and then competing against the former employer
without the financial security of his (former) compensation. This case bears
no resemblance to that paradigm.
Here, the Longs do not intend to put themselves at risk by first (i)
leaving their employ at WSA and abjuring their corporate compensation, (ii)
abandoning their strategy of obstructing all efforts to locate buyers willing to
pay fair market value for the Company, (iii) remaining content to accept
Long’s 50% share of the purchase price, and then (iv) competing with WSA,
which would operate as an intact, fully operational competitor. Rather,
when the Long interests speak of being free to “compete,” what they have in
mind is continuing to receive their sizeable incomes as WSA employees,
continuing to scare away competitive bidders, and continuing to impede any
efforts to secure the continuity of WSA’s operations by documenting the
computer software (a sine qua non for any buyer except the Longs). In this
manner-and at no financial risk to themselves-the Long interests would
thereby appropriate Fulk’s share of WSA’s going concern value, by
depriving Fulk of any alternative except to sell his 50% share of WSA to
Long at whatever artificially low price Long chooses to offer.
Long cites no case, nor has any authority otherwise been brought to
this Court’s attention, that validates “competition” by a fiduciary under these
“heads I win; tails I win” rules.
In truth, Long’s “right to compete”
argument is a rhetorical smokescreen, designed to divert attention from the
real issue. That issue is whether Long’s threat to compete while remaining
an employee with fiduciary obligations to WSA and to Fulk, affords Long a
legally valid basis to block off all potentially interested bidders except
himself, to avoid paying Fulk the value that a genuine bidding contest, not
constrained by Long’s threatened breaches of duty, would obligate him to
pay. The answer to that question is clearly no.
Section 273 creates a substantive right, in each 50% stockholder, “to
have his investment protected from depletion or loss due to a deadlock
between the two fifty-percent stockholders and a resulting paralysis in the
corporation’s ability to conduct business and fulfill the purpose for which it
was created.“32
This Court has “the equity power to grant the appropriate
relief necessary to protect [a 50% stockholder’s] investment in the assets of
[the corporation] from depletion.“33
That includes the general equity power
32 In r-e English Seafood (USA), Inc., 743 F. Supp. 281,288 @. Del. 1990).
33 Id.
to enjoin threatened breaches of fiduciary duty,34 and the specific equity
power, conferred by Section 273, “to protect the interests of stockholders
when they are threatened, and to enforce the duties of fiduciaries in which
allegations of wrongdoing are made.“35
Accordingly, I find no merit in Long’s contention that Long’s “right
to compete” trumps this Court’s inherent equity power, and its statutory
power under Section 273, to order the sale of a business upon terms that
would prevent a breach of fiduciary duty consisting of improperly diverting
the economic interest of one of the firm’s 50% owners to the other.
Third, Long argues that the provisions in the proposed Plan of Sale
that would enjoin Long (or Fulk) from soliciting WSA’s current or former
customers or from using WSA’s computer software for 180 days after the
34 E. I. DuPont de Nemours & Co. v. Am. Potash & Chemical Corp., 200 A.2d 428,432
(Del. Ch. 1964); accord, Wilmont Homes, Inc. v. Weiler, 202 A.2d 576, 580 (Del. 1964).
35 In re Arthur Treacher ‘s Fish & Chips of Ft. Lauderdale, Inc., 386 A.2d at 1166. The
fiduciary analysis employed here is consistent with the result reached in cases decided in
other jurisdictions, which recognize that the sale of a going concern business necessarily
includes the goodwill or going concern value of the business. To protect the buyer of
such a business, those courts have enjoined the seller of the business from soliciting the
customers of the business being sold, or from competing with that business, in order to
protect the business’s going concern value. In granting that relief, some cases have
implied a nonsolicitation or noncompetition agreement in order to protect the buyer’s
goodwill interest. See, e.g., MohawkMaint. Co. v. Kessler, 419 N.E.2d 324, 330 (N.Y.
1981); Tobin v. Cody, 180 N.E.2d 652,656 (Mass. 1962); Certified Pest Control, Inc. v.
Kuiper, 294 N.E.2d 548,550-51 (Mass. App. 1973); Worgess Agency, Inc. v. Lane, 239
N.W.2d 417,422 (Mich. App. 1976). This Court reaches the same result here on
fiduciary duty and statutory grounds, without expressing any view about the merits of the
implied contract rationale adopted in the non-Delaware authorities cited above.
34
sale, are improper because the customers’ identity and the computer
software are not trade secrets. The short answer is that it does not matter
whether the customers or computer software are “trade secrets” under the
Delaware Uniform Trade Secrets Act,36 because in all events that
information is proprietary, i.e., the property of WSA. As such, that property
cannot be used by a fiduciary to WSA’s detriment without the Company’s
permission. Neither Fulk nor Long has any individual property right to the
Company’s proprietary assets. Accordingly, this Court is fully empowered
to protect those assets against expropriation in a sale of the Company as a
going concern under Section 273.37
36 6 Del. C. $ 2001-2009.
37 Although I do not decide the trade secret issue, if the Court were required to decide
whether the customer-related information and the computer software information were
trade secrets under the Trade-Secrets Act, it would likely so hold. The computer software
clearly satisfies the criteria for a protected trade secret under that Act, 6 Del. C. $
2001(4), with the result that were Fulk to acquire WSA, the Longs would not be entitled
to use their knowledge of WSA’s proprietary computer systems to engage in a competing
business. With respect to the customer information, Long protests that the identity of
WSA’s customers is not a trade secret, since that information is well-known and no effort
was made to keep it a secret. That may be so, but the argument ignores the other
customer-related information that is secret and that, if disclosed, would be harmful to
WSA, namely, the specific services provided to the customers, the customers’ specific
requirements, and the.pricing associated with those services. Long’s failure to address
those categories of customer-related information in any reasoned way tacitly concedes
that that information constitutes a trade secret.
D.
The Reasonableness of
The Injunctive Terms
The final set of issues involves Long’s challenge to the reasonableness
of two specific terms of the proposed Plan of Sale. Long argues that it is
unreasonable to prevent him from competing against an entity (WSA) that
will have no ongoing business and will be dissolved. That argument merely
restates, in a different form, contentions that have already been made and
rejected. The short answer is that WSA will not necessarily be dissolved,
but will be sold as a going concern with its ongoing business intact.
Accordingly, this argument fails for want of a valid premise.
Long’s remaining contention is that it is unreasonable to require the
selling stockholder to accept the promissory note of the buyer as
consideration, because that would force one stockholder to become a
creditor of the other in circumstances where it is in the best interest of
everyone to sever all iheir relationships after the sale.
But, I do not
understand that Long, if he becomes the buyer, would be categorically
required to deliver a note to Fulk, as the seller. Nothing in the Plan
precludes an all-cash transaction, particularly if the buyer has the needed
funds or is able to borrow them from a commercial lender. If Long wishes
to pay cash for Fulk’s 50% interest, he is free to do so. The use of a note to
enable a sale on a deferred payment basis appears intended as an alternative
financing option in circumstances that would create minimal risk to the
seller, since the note would be accompanied by a guarantee executed by the
purchaser’s family, and would also be secured by a pledge of 100% of the
shares of WSA as collateral.
Accordingly, I am unable to conclude that the promissory note feature
of the proposed Plan of Sale, in these circumstances, is unreasonable.
IV. CONCLUSION
For the foregoing reasons, the Court overrules the objections to the
Custodian’s proposed Plan of Sale.
The parties shall confer upon, and
submit for entry by this Court, an appropriate form of implementing Order.
