Delaware Provides Predictability of Outcome

Steven D. Goldberg, Esq.
Wilmington, DE
Contact me if you need assistance in forming/organizing a Delaware business entity or any matter of Delaware law.
On April 6, 2010, the Delaware Supreme Court entered its decision in the consolidated cases of Nemec v. Shrader and Wittkemper v. Sharder. Nemech and Wittkemper were former stockholders of the consulting firm Booz Allen. The defendants were the directors of the company. When the pettioners retired they had a 3 year window to put un-executed options to the company at “book value”, after that 3 year period the company had the right to redeem the options at “book value” at any time.

The petitioners having failed to exercise their put right, the Company exercised its right to redeem the options. The issue sub judice arose over the timing of the redemption. It appears that at the time of the redemption the Board was aware that the company was about to enter into a transaction to sell a portion of the company for $2.54 billion. The result of the timing was to shift $60 million from the proceed that the petitioners would have received from the transaction to the active stockholders including the Directors.

The petitioners alleged that the company violated the implied contratual covenant of good faith and fair dealing.  According to the petitioners the company’s decision to redeem the shares when it did was made in bad faith.

The Court of Chancery had dismissed the petitioners claims and they appealed. The Supreme Court stated that “[w]e cannot reform a contract because enforcement of the contract as written would raise ‘moral questions’.” In its decision it stated that it would only imply contract terms if a party had acted “arbitrarily or unreasonably” and had denied the other party the benefit of their bargain. “Parties have a right to enter into good and bad contracts, the law enforces both.”

At a visceral level one could argue that the shift of $60 million must logically violate the implied contractual covenant of good faith and fair dealing. After getting past the visceral level you can see that the court was absolutely correct. This is not the case of widows or orphans being taken advantage. The two petitioners were stockholders of one of the nation’s most sophisticated consulting firms. In hind sight they made a bad bargain by allowing the company unfettered timing of the redemption, but that was their deal, like it or not. The Court stated that it will enforce “bad contracts”.

As lawyers we look to the courts for predictability of outcome. We want the courts to enforce the contracts that people negotiate and sign. We do not want courts re-writing parties agreements because the court concluded that they had entered into a bad deal or another parens patrea reason. This predictability of outcome is one of several reasons that practitioners choose Delaware business entities as that choice makes Delaware courts available to their clients. See my recent post Institute for Legal Reform Ranks Delaware’s Legal Climate Number 1 In the Nation.

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