August 23, 2010

Delaware Chancery Refuses to Apply Choice of Law Provision in Investment Bank’s Engagement Letter

From Kevin Miller of Alston & Bird: In Shandler v. DLJ Merchant Banking, a recent decision of the Delaware Court of Chancery, the Chancery Court refused to apply the choice of law provision in an investment bank’s engagement letter to a claim alleging that the investment bank had aided and abetted a breach of fiduciary duty.

Noting that the choice of Ohio law would have been outcome determinative (Ohio law does not appear to recognize claims for aiding and abetting a breach of fiduciary duty, and the application of Ohio law would have required the dismissal of that claim against KeyBanc), the Delaware Chancery Court held that:

“the mere fact that any contractual or malpractice obligations KeyBanc owed to Insilco were governed by Ohio law does not give Ohio a stronger interest in[sic] Delaware as to an aiding and abetting claim. When the claim against a third-party is that it was knowingly complicitous in a breach of fiduciary duty against a Delaware entity, Delaware’s interest is paramount. Because Delaware has the strongest interest, because our law recognizes aiding and abetting claims, and because the complaint clearly states such a claim against KeyBanc. . . , its motion to dismiss is denied.”

While not cited by the Shandler Court, § 187(2) of the Restatement (Second) of Conflict of Laws would appear to provide the appropriate basis for resolving this issue. In pertinent part, § 187(2) of the Restatement provides that:

“The law of the state chosen by the parties to govern their contractual rights and duties will be applied, even if the particular issue is one which the parties could not have resolved by an explicit provision in their agreement directed to that issue, unless . . . (b) application of the law of the chosen state would be contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue and which, under the rule of § 188, would be the state of the applicable law in the absence of an effective choice of law by the parties.”

However, where Courts, applying § 187(2) of the Restatement, have determined that the application of the law of the chosen state would be contrary to fundamental policy of a state with materially greater interest, they have typically relied on an express statutory provision of the state whose laws would otherwise be applicable that application of the law of the chosen state would violate a fundamental policy (e.g., finding that an indemnification provision in a construction contract providing indemnification for a party’s own negligence was contrary to a fundamental policy of the state with a materially greater interest where a statute of the state with a materially greater interest specifically prohibited such indemnification in construction contracts). Absent a statute declaring a contractual provision against public policy and/or null and unenforceable, it is not clear that a Court, applying § 187(2) of the Restatement, would find such provision sufficiently repugnant to a fundamental state policy.

In Shandler, it is not clear that, applying § 187(2) of the Restatement, the application of Ohio law would be contrary to a fundamental policy of the State of Delaware:

– while Section 102(b)(7) of the DGCL does not permit a Delaware corporation’s charter to exculpate its directors for breaches of their duty of loyalty or for acts or omissions not in good faith or which involve intentional misconduct, no Delaware statute prohibits a Delaware corporation from exculpating its financial advisors or other independent contractors for aiding and abetting such breaches;

– Section 145 of the DGCL only limits the power of a Delaware corporation to indemnify directors, officers, employees and agents of the corporation, not its financial advisors or other third party consultants;

– Many merger agreements contain provisions pursuant to which the buyer agrees to indemnify a Delaware target’s board of directors for a variety of claims, including claims with respect to which the Delaware Target could not provide exculpation (e.g., “The proxy specifically states that Caremark’s directors will be indemnified not only “to the same extent such individuals are indemnified pursuant to Caremark’s certificate of incorporation and bylaws” but also “to the fullest extent permitted by law . . . .” This conjunctive language suggests an intent to grant indemnity in excess of that already offered by Caremark.”;

– Delaware law permits sophisticated parties such as parties to an LLC Agreement to agree to extremely broad exculpatory provisions which can cover breaches of the duty of loyalty by fiduciaries; and

– in Shandler, the plaintiff Trustee stood in the shoes of one of the sophisticated parties that entered into the contract containing the Ohio choice of law provision.

Refusing to enforce such a choice of law provision, permits a sophisticated party to effectively sandbag its counterparty by depriving the counterparty of the benefits of a contract otherwise governed by the laws of its home state for which it bargained even where the contractual provisions at issue are not void or voidable under the laws of a state the sophisticated party later argues has a materially greater interest.