Chordia v. Lee, 2023-0382-NAC (Del. Ch. Jan. 4, 2024) (Cook, V.C.)

In this post-trial memorandum opinion, Vice Chancellor Cook held that Alphonso Inc. (“Alphonso” or the “Company”) breached a “reasonable efforts” provision of a Stockholders’ Agreement (the “Stockholders’ Agreement”) between Alphonso, its founders, and other key stockholders (such stockholders together with the founders, the “Key Holders”), which required Alphonso to use reasonable efforts to ensure the effectiveness of the rights of the Key Holders set forth in the Stockholders’ Agreement, including a right to designate directors.

The Stockholders’ Agreement was entered into in December 2020 in connection with the acquisition of a majority interest in Alphonso by Zenith Electronics LLC (“Zenith”), an indirect subsidiary of LG Electronics, Inc. (“LGE”).  The Stockholders’ Agreement provided the Key Holders who served as officers or employees of Alphonso the right to designate three members of Alphonso’s seven member Board (the “Common Directors”), so long as at least one of the Key Holders remained an officer or employee of Alphonso (the “Designation Condition”).  The Stockholders’ Agreement gave LGE the right to designate Alphonso’s other four Board members.  The Board was also given the exclusive right to hire and fire executive officers and employees who received annual compensation over $500,000.  The Stockholders’ Agreement further required that Alphonso use its “reasonable efforts” to ensure that the rights conferred in the Stockholders’ Agreement remained effective, which specifically included that the Company must use “reasonable efforts to cause the nomination and election of directors as provided in [the Stockholders’ Agreement]” (the “Efforts Clause”).

After the acquisition, in 2022, significant disagreements and friction broke out among the directors of the Company, which led LGE to seek to eliminate the Key Holders’ designation right.  By terminating all Key Holder officers and employees, the Designation Condition would no longer be satisfied, and the terms of the Stockholders’ Agreement would permit LGE to remove all of the Common Directors.  At the time, there were five Key Holder officers or employees at the Company.  Of those five, three were executive officers and two were non-executive employees.  To carry out its plan, the LGE-controlled Board unilaterally terminated all three of the Key Holder executive officers.  Because the Board did not have the power to fire non-executive employees, however, the Board appointed an interim CEO and directed him to terminate the two non-executive Key Holder employees to accomplish the plan.  The Plaintiffs established at trial that the Board appointed the interim CEO “as a warm body to do the dirty work that it could not[,]” and the interim CEO’s testimony suggested that he had no basis for terminating the non-executive Key Holder employees “other than blindly following [LGE’s] instructions.”  Following the terminations, no Key Holder served as an officer or employee of the Company, as required for the Key Holder’s right to designate directors pursuant to the Designation Condition.  Zenith executed a written consent to remove all of the Common Directors from the Board shortly thereafter.

The Key Holders challenged the written consent and sought a determination of the Board’s proper composition pursuant to 8 Del. C. § 225.  Thus, the Court considered whether the written consent to remove the Common Directors was invalid as a result of a breach of the Stockholders’ Agreement in connection with the termination of the Key Holder officers and employees to cause the non-occurrence of the Designation Condition.  After examining the Stockholders’ Agreement and finding that its express terms permitted the Board to terminate the Key Holder executive officers, the Court assumed without deciding that the Defendants were correct that the Efforts Clause obligated only the Company, and not the Board, to use reasonable efforts to ensure the effectiveness of the rights granted in the Stockholders’ Agreement.

Accordingly, the key question was whether Alphonso breached the Efforts Clause when the interim CEO terminated the non-executive Key Holder employees.  The Court found that even though the interim CEO believed he was exercising the power to terminate non-executive employees within the scope of authority held by the Company’s CEO, he overlooked the express bargained-for “reasonable efforts” obligation that Alphonso agreed to as a party to the Stockholders’ Agreement.  The Court explained that the Efforts Clause required the Company to “take all reasonable steps” to “make certain” that the non-executive Key Holder employees’ rights, including the designation right, were “operative” and “productive.”  Moreover, the Court held that Alphonso’s obligations under the Efforts Clause operated to limit the CEO’s “right” to terminate employees as it pertained to the non-executive Key Holder employees.  Specifically, the Court asked whether the Company had reasonable grounds to take the action it did and whether the Company sought to address its problems with the non-executive Key Holder employees.  The Court found that the Company did not have reasonable grounds to terminate the non-executive Key Holder employees and that the Company took no steps to resolve the issues with the non-executive Key Holder employees, opting instead for the nuclear option.

Therefore, the Court held that Alphonso breached the Efforts Clause when the interim CEO, acting for Alphonso, terminated the non-executive Key Holder employees for the purpose of causing the non-occurrence of the Designation Condition and depriving the non-executive Key Holder employees of their rights under the Stockholders’ Agreement.  More specifically, the Court held that Alphonso’s breach of its obligations under the Efforts Clause excused the Designation Condition, that the non-executive Key Holder employees’ designation right remained operative, and that the written consent to remove the Common Directors was invalid.

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