Topics In This Issue

• SEC's Division of Corporation Finance Issues New Guidance on Shareholder Proposals
• Delaware Chancery Court Addresses Disclosure Duties of Director Negotiating Release with Corporation
• SEC Complaint May Jeopardize Insurance Coverage

SEC's Division of Corporation Finance Issues New Guidance on Shareholder Proposals
 

The SEC's Division of Corporation Finance issued a legal bulletin changing the way its staff will analyze whether a company may exclude shareholder proposals relating to risk or focusing on succession planning in reliance on Rule 14a-8(i)(7). The rule provides for exclusion of a proposal that "deals with a matter of the company's ordinary business operations."

In the bulletin, which was posted October 27, 2009, the Division explained that, in the past, the SEC has analyzed company requests to exclude proposals relating to environmental, financial or health risks based on whether the proposal and supporting statement as a whole related to the company engaging in an evaluation of risk, which the SEC viewed as relating to a company's ordinary business operations.

To the extent that a proposal and supporting statement focused on a company engaging in an internal assessment of the risks and liabilities faced by the company as a result of its operations, the SEC had permitted companies to exclude the proposal under Rule 14a-8(i)(7) as relating to an evaluation of risk.

According to the bulletin, the staff has received a number of company no-action requests seeking to exclude proposals as relating to an evaluation of risk based on the argument that, while the proposal at issue did not explicitly request an evaluation of risk, it should nonetheless be excludable under Rule 14a-8(i)(7) because it would require the company to engage in risk assessment.

"Based on our experience in reviewing these requests, we are concerned that our application of the analytical framework … may have resulted in the unwarranted exclusion of proposals that relate to the evaluation of risk but that focus on significant policy issues," said the staff.

According to the bulletin, on a going-forward basis, the staff will focus on the subject matter to which the risk pertains or that gives rise to the risk instead of analyzing whether the proposal and supporting statement might relate to risk evaluation.

Under the new interpretation, the fact that a proposal would require an evaluation of risk will not be dispositive of whether the proposal may be excluded under Rule 14a-8(i)(7). Instead, the staff "will consider whether the underlying subject matter of the risk evaluation involves a matter of ordinary business to the company."

According to the bulletin, "in those cases in which a proposal's underlying subject matter transcends the day-to-day business matters of the company and raises policy issues so significant that it would be appropriate for a shareholder vote, the proposal generally will not be excludable under Rule 14a-8(i)(7) as long as a sufficient nexus exists between the nature of the proposal and the company."

The bulletin also states that the staff has received a number of no-action requests from companies seeking to exclude proposals relating to CEO succession planning. Historically, the staff has expressed the view that these proposals could be excluded in reliance on Rule 14a-8(i)(7) because such proposals related to the termination, hiring or promotion of employees.

However, based on a recognition that "CEO succession planning raises a significant policy issue regarding the governance of the corporation that transcends the day-to-day business matter of managing the workforce," the Division had decided to modify its treatment of such proposals. According to the bulletin, going forward, a company generally may not rely on Rule 14a-8(i)(7) to exclude a proposal that focuses on CEO succession planning. top

Delaware Chancery Court Addresses Disclosure Duties of Director Negotiating Release with Corporation
 

In 2008, Heckmann Corporation purchased via merger a Chinese bottled water producer and distributor founded by Xu Hong Bin. The purchase price included cash, a right to additional contingent payments, and restricted shares in Heckmann. The agreement also provided that Xu would continue as president of the Chinese entity, and would become a director of Heckmann.

Following closing, Heckmann and Xu entered an Escrow Resolution and Transition Agreement (the "Transition Agreement") to manage certain post-closing issues. The Transition Agreement included a mutual release of claims between Xu and Heckmann A dispute developed, and Xu filed suit against Heckmann in the Delaware Chancery seeking specific performance of the Transition Agreement. Heckmann counterclaimed, asserting, among other things, that Xu breached his duty as a director to disclose fraudulent conduct in negotiating the release contained in the Transition Agreement.

Xu moved to dismiss the counterclaims, arguing that the release contained in the Transition Agreement released him from any claims by Heckmann "whether known to Heckmann or China Water at the time of execution of this Agreement or not…." Heckmann argued that because it was not aware of Xu's fraud at the time the Transition Agreement was negotiated, the release could not be effective as to those claims.

The Chancery Court determined that it could not dismiss Heckmann's counterclaim, because factual issues remained regarding Heckmann's knowledge of Xu's alleged fraud. The Court agreed that if Heckman was unaware of Xu's fraud during negotiation of the Transition Agreement, which occurred after Xu became a director, than Xu "clearly had a fiduciary duty to inform Heckmann that the release would cover his alleged fraudulent conduct because the information would have been material to Heckmann's decision to enter the [Transition Agreement]."

The Court drew a careful distinction, however, between situations where a corporation and its director enter a release as a matter of course as part of an agreement and situations in which the purpose of the agreement is to settle potential claims.

The Court stated that if Heckman was aware of "suspicions or allegations that the director committed fraud," and the release was intended to settle those potential claims, the release would be enforceable "even if the full scope of those claims is unknown when the release is signed."

Because the Court determined that issues of fact remained regarding whether Heckmann was aware of "suspicions or allegations" of fraud, the Court denied Xu's motion to dismiss. Read the Chancery Court's full opinion in Xu v. Heckmann Corporation, No. 4673 (De. Ch. October 26, 2009). top

SEC Complaint May Jeopardize Insurance Coverage

In Rivelli v. Twin City Fire Ins. Co., Case No. 08-1480 (10th Cir. Oct. 26, 2009), the United States Court of Appeals for the Tenth Circuit addressed a claim by directors and officers of Fischer Imaging Co. that Twin City denied advancement of fees and expenses under a D&O policy. In May 2005, the SEC filed a fraud enforcement action against the directors and officers, which was subsequently amended in 2008 to allege that the directors and officers engaged in a scheme to inflate the earnings of Fischer Imaging between 2000 and 2002.

The company had purchased both excess and top layer D&O coverage from Twin City. When the company renewed its top layer coverage in 2002, it provided a warranty to Twin City representing that no covered person had any knowledge or information of any "act, error, omission, fact or circumstance" that could give rise to a claim under the policy.

Twin City ultimately denied coverage based on the alleged falsity of that warranty. After the directors and officers filed a suit seeking coverage under the policy, and after motions for summary judgment filed by both parties, the trial court agreed with Twin City that it had no coverage obligation.

In affirming, the Tenth Circuit relied on the so-called "Colorado complaint rule," which provides that an insurer's duty to defend is determined by considering only the policy and the complaint filed against the insured. The court found that because the SEC's complaint alleged that the defendants participated in the fraudulent acts which gave rise to the securities claims, and because those alleged acts took place before the renewal of the D&O policy containing the knowledge warranty, Twin City was entitled to deny coverage. top

Contributors to this issues are Dan Pirolo, Hunter Port and Marcy Greer.