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DBCI: O’Connell on High Court Clarifies Reach of Director and Officer ‘Consent’ Statute

In the April 13, 2016 edition of the Delaware Business Court Insider, LRC partner Tyler O’Connell writes that in Hazout v. Ting, the Delaware Supreme Court recently provided a new, relatively expansive interpretation of Delaware’s so-called director and officer “consent” statute, and in doing so rejected longstanding precedent that applied a narrower interpretation as inconsistent with the statute’s plain meaning.

High Court Clarifies Reach of Director and Officer ‘Consent’ Statute

By K. Tyler O’Connell

In Hazout v. Ting, __ A.3d __, 2016 Del. LEXIS 103 (Del. Feb. 26, 2016) (“Hazout”), the Delaware Supreme Court recently provided a new, relatively expansive interpretation of Delaware’s so-called director and officer “consent” statute, 10 Del. C. § 3114 (“Section 3114”), and in doing so rejected longstanding precedent that applied a narrower interpretation as inconsistent with the statute’s plain meaning.

Section 3114 provides that all directors of Delaware corporations, along with the officers described in section (b) thereof, may be served with process at the office of the corporation’s Delaware registered agent or, if there is none, the Secretary of State, in “all civil actions or proceedings brought in this State, by or on behalf of, or against such corporation, in which such director … is a necessary or proper party, or in any action or proceeding against such director, trustee or member for violation of a duty in such capacity[.]” (emphasis added).  The italicized language defines the types of legal proceedings for which directors and covered officers are deemed to have consented to Delaware’s exercise of jurisdiction.  Beginning with precedent such as Hana Ranch, Inc. v. Lent, 424 A.2d 28 (Del. Ch. 1980) (“Hana Ranch”), Delaware courts declined to give independent life to the first part that formulation: actions “by or on behalf of, or against such corporation, in which such director … is a necessary or proper party” (the “Necessary or Proper Party Provision”), due to concerns that it could be read to apply in a manner that exceeds the constitutional limits on a state’s exercise of personal jurisdiction over a non-resident.  A line of decisions followed Hana Ranch by applying limiting constructions, reasoning that the statute should be applied only where the suit involved issues of compliance with fiduciary duties and statutory obligations under the Delaware General Corporation Law.  The result was that the Necessary and Proper Party Provision was effectively read out of the statute.

Hazout presented an opportunity to re-examine that line of cases.  There, the defendant-director objecting to jurisdiction, Marc Hazout, also served as the President and CEO of Silver Dragon Resources, Inc. (“Silver Dragon” or the “Company”), a financially distressed Delaware corporation with its place of business in Toronto, Canada.  Hazout, a Toronto resident, also was the sole owner of one of Silver Dragon’s largest stockholders and creditors.  The plaintiff allegedly led a group of investors who, in late 2013, agreed to make a $3.4 million loan secured by all of Silver Dragon’s assets in exchange for effective control in virtue of a series of related contracts that included rights to designate four directors to the company’s five-member board.  Four of five agreements included Delaware choice of law provisions, and one (a line of credit agreement) contained a Delaware consent to jurisdiction provision.  The investors alleged that they regretfully wired the first installment of the loan based on Hazout’s promise that executed copies of the agreements and the incumbent directors’ resignations would be forthcoming shortly.  After Hazout allegedly failed to provide these, and instead kept all the money and then transferred most of it to a Canadian entity he controlled, the plaintiff brought suit against Hazout in Superior Court alleging fraud, unjust enrichment and fraudulent transfers.  When Hazout moved to dismiss for lack of personal jurisdiction, the Superior Court agreed that he was not subject to Delaware’s long-arm statute, but held that he was subject to Section 3114.  While acknowledging the precedent narrowing Section 3114’s scope, the Superior Court reasoned somewhat expansively that, although no fiduciary duty claim was alleged, the alleged conduct involved fraud committed using corporate offices – which would be inimical to his fiduciary duties and, the Court reasoned, therefore should suffice as a “any action or proceeding against such director … for violation of a duty in such capacity” under Section 3114.  See Ying v. Silver Dragon Res., Inc., 2014 Del. Super LEXIS 277, at *12 (Del. Super. Jun. 3, 2015).

Arguing this result was contrary to precedent such as Hana Ranch, Mr. Hazout filed an interlocutory appeal, which the Delaware Supreme Court accepted. The Supreme Court affirmed, however, on the alternative ground that jurisdiction was proper based on the plain language of the Necessary or Proper Party Provision; the action was a suit “against such corporation” – Silver Dragon, a named defendant – “in which such director … is a necessary or proper party[.]”  Rejecting the argument that the Necessary and Proper Party Provision was facially invalid, the Court reasoned that it “contains its own safeguards against overbreadth.”  Hazout, 2016 Del. LEXIS 103, at *36-37.  Because the corporation also must be a party, it requires a “close nexus between the claims involving the corporation … and the conduct of the nonresident fiduciary.”  Id. at *37.  Thus, the Court explained, only conduct by a nonresident “using his corporate power will make him a necessary or proper party” under Section 3114.  Id.  The Court agreed that there were conceivable circumstances in which a plain reading of the Necessary and Proper Party Provision could be “constitutionally questionable,” such as for example a products liability case involving a product distributed from another state to diverse consumers, most of whom are outside of Delaware.  Id. at *43 n.60.  The Court also reasoned that the doctrine of forum non conveniens may apply to limit the cases of which Delaware courts exercise jurisdiction.  Having concluded that the exercise of jurisdiction comported with Section 3114, the Court also found the exercise of jurisdiction over Hazout would comport with constitutional limits of due process.  The Court reasoned this was not a particularly difficult question, given that (i) the case challenged Hazout’s actions in an “official capacity of negotiating contracts that involved the change of control” of a Delaware corporation, and (ii) the parties included Delaware choice of law provisions in their agreements and even consented to exclusive jurisdiction in Delaware for actions brought under one such agreement.  Id. at *48.  The Supreme Court accordingly affirmed the denial of Hazout’s motion to dismiss.

By requiring that Section 3114 be applied in accordance with its plain language, Hazout clarifies the analysis for the exercise of personal jurisdiction in a way that facilitates plaintiffs’ ability to argue that non-resident directors and officers should be subject to suit in Delaware in actions that do not involve fiduciary duty claims. As illustrated by the Supreme Court’s decision, this interpretive shift likely will lead to further development of caselaw concerning the constitutional limits of due process that apply when Delaware exercises jurisdiction over non-resident directors and officers.  In this regard, the Court reasoned that the applicability of Delaware law and Delaware’s interest in resolving the kinds of claims at issue are important to the due process “minimum contacts” analysis.  Delaware courts have experience considering these factors when addressing constitutional limits of due process under the Limited Liability Company Act’s “consent” statute, 6 Del. C. § 18-109, which on its face applies in any actions “involving or relating to the business of the [entity] or a violation by the manager … of a duty to the limited liability company or any member of the limited liability company.”  In that context, in considering the permissible scope of the potentially broad “involving or relating to” language, the courts’ due process analysis has focused on whether (i) the allegations “focus centrally” on the defendant’s “rights, duties and obligations” in the capacity as a manager; (ii) the matter is “inextricably bound up in Delaware law;” and (iii) Delaware has a strong interest in providing a forum for the resolution of the dispute …”  See Hartsel v. Vanguard Group, Inc., 2011 Del. Ch. LEXIS 89, at *34 (Del. Ch. Jun. 15, 2011), aff’d, 38 A.3d 1254 (Del. 2012).  Going forward, it stands to reason that the application of the minimum contacts test in the limited liability company context should inform its application in the corporate context, and vice versa.  Finally, Hazout illustrates the importance of including Delaware forum selection clauses in contracts governing Delaware entities’ significant transactions.  While the Hazout parties did this for one of their five agreements, the forum selection clause apparently did not reach all of the claims at issue, else this threshold jurisdictional dispute could have been avoided.

Tyler O’Connell is a partner at Landis Rath & Cobb LLP. Tyler represents parties in connection with disputes over the ownership, control and management of Delaware corporations and alternative entities. Tyler also counsels investors and members of management in connection with transactions that entail a significant risk of litigation. 

Reprinted with permission from the April 13, 2016 issue of the Delaware Business Court Insider. © 2016 ALM Media Properties. Further duplication without permission is prohibited.