First Circuit Court Surprises Media Lawyers with Controversial Decision in Libel Case

A recent decision by the 1st Circuit against Staples, Inc. surprised many media lawyers by holding that truth is not an absolute defense to a libel claim. It held that a truthful statement may give rise to a cause of action by a private-figure plaintiff if it was made maliciously. The decision departs from decades worth of jurisprudence establishing truth as an absolute defense to a defamation claim.

No doubt the extreme facts in this case drove the Court’s outcome. The case was brought by a former Staples employee who was terminated for “cause” submitting false expense reports. The termination took place after an extensive internal investigation that uncovered the fraud. After the termination, a manager issued an email to 1,500 Staples employees stating that the employee had been terminated for abusing the travel & expense policy. (The court’s commentary seems to suggest that the fact that employee was mentioned by name in this en masse email is what they thought a jury could consider to be malicious. Although the court held that there was no question that the statement in the email was true, it nonetheless allowed a libel claim to stand based on a 1902 law (G.L.c.231, sec. 92) that provides that truth is a justification for libel "unless malice is actually proved."

It is important to note, however, that this decision does not mean that Staples loses on this claim. The 1st Circuit remanded the case back to the US District Court for trial where a jury may still find that the manager’s email did not constitute malice.

Another interesting part of the decision deals with stock options. As part of the for “cause” termination, the employee’s vested stock options were terminated per the terms of the option plans. The agreements provided that whether or not termination is for cause would be “as determined by Staples, which determination shall be conclusive.” Finding no prior Mass. law on this issue, the 1st Circuit held it will not second guess the Company’s termination decision unless it finds that it was “arbitrary, capricious, or made in bad faith,” which in this case was based extensive internal investigation and therefore was allowed to stand.

In this market where layoffs are looming in just about every industry, this case underscores the importance of proper procedure (and tact) in handling terminations. Based on this decision, employers should be additionally cautious when handling any announcements internal or external and discussions regarding anyone being terminated, as well as in the context of giving references or referrals. And while not all employers have Staples’ budget to conduct internal investigations to find "cause", any determination of such a finding should be well documented.

Best state for incorporation

The folks for www.askthevc.com have a good post on best state for incorporation if you are thinking about venture capital. I agree that Delaware is really the best choice, but there are variations. I also am not a huge fan of Massachusetts, which, unlike Delaware, still has the annoying procedural requirement that they need original signatures for an effective filing. Another issue with Massachusetts is that you have to opt in, in a written provision in your charter, that shareholder consents do not have to be unanimous to be effective. If you forget to do this when you form the Company, you have to chase every shareholder, or call a meeting - which creates additional issues at closing that people don't always plan.

I think another interesting topic is choice of entity. Most vcs dont favor LLCs, and yet that may be the right structure. Perhaps I will take that on in a future post.

Recent Massachusetts decision on director and shareholder duties

A recent decision by the Massachusetts Superior Court for Suffolk county (Boylan v. Boston Sand & Gravel Co., 2007 WL 836753 (Mass.Super.) has a very good synthesis of duties owed by directors and stockholders of Massachusetts corporations:

"[The defendants] as directors of [the company] , owed a fiduciary duty to the corporation, which included both a duty of care and a duty of loyalty. Demoulas v. Demoulas Super Markets, Inc., 424 Mass. 501, 528 (1997). Since they were both directors and shareholders of [the company] and since [the company]was a closely-held corporation, they owed their fellow shareholders, ..., “substantially the same duty of utmost good faith and loyalty in the operation of the enterprise that partners owe to one another, a duty that is even stricter than that required of directors and shareholders in corporations generally.” Id. at 529; Donahue v. Rodd Electrotype Co. of New England, Inc., 367 Mass. 578, 592-594 (1975).

*7 If [the defendants] wished [the company] to engage in a self-dealing transaction ... they must:
1. make full and honest disclosure of all the known material facts of the proposed transaction, including the details of the transaction and their conflict of interest; Demoulas at 531. See Puritan Medical Ctr. Inc. v. Cashman, 413 Mass. 167, 172 (1992); Dynan v. Fritz, 400 Mass. 230, 243 (1987) (“good faith requires a full and honest disclosure of all relevant circumstances to permit a disinterested decision maker to exercise its informed judgment”); ALI Principles of Corporate Governance § 5.02(a) (1994); and
2. “then either receive the assent of disinterested directors or shareholders, or otherwise prove that the decision is fair to the corporation.” Demoulas at 533. The burden of proving that the assenting directors were disinterested rests with the self-dealing directors, see Houle v. Low, 407 Mass. 810, 824 (1990), as does the burden of proving that the self-dealing was “intrinsically fair, and did not result in harm to the corporation or partnership” if the transaction was approved by self-interested directors. Demoulas at 530-531, quoting Meehan v. Shaughnessy, 404 Mass. 419, 441 (1989).


If the self-dealing directors fail to provide full disclosure of the material facts of their proposed transaction, then they breach their fiduciary duty by proceeding with the transaction, regardless of its approval by the Board or its fairness to the corporation. See Geller v. Allied-Lyons PLC, 42 Mass.App.Ct. 120, 128 (1997) (“full disclosure of all material facts respecting the finder's fee agreement [is] a prerequisite for enforcement”). The Board's approval is vitiated by the failure of full disclosure.

If the self-dealing directors provide full disclosure to the Board and the transaction is approved by the disinterested directors, then the decision enjoys the deference provided by the business judgment rule. See Harhen v. Brown, 431 Mass. 838, 847 (2000). If the self-dealing directors provide full disclosure to the Board and the transaction is approved by self-interested directors, the decision does not enjoy the benefit of the business judgment rule and must be demonstrated to be fair to the corporation. Demoulas at 533."

Brown University Venture Forum for Enterprise Slide Deck

I recently spoke at a program on valuation and term sheets at Brown University put on by the Brown Forum for Enterprise. I discussed the topic of valuation issues surrounding stock options and 409A. The slide deck can be viewed here.

Study for West Coast VC Deals in Life Sciences

Fenwick publishes a quarterly study of VC deal activity in various areas. The most recent life sciences report can be found here: http://www.fenwick.com/vctrends/LS_VC_Survey_2006.htm?WT.mc_id=LSVCS_032707_e-mail-corp

Delaware Chancery Court rules on post-closing adjustment dispute

A March decision of the Chancery Court in Matria Healthcare v. Coral SR LLC is an essay on post-closing adjustment (true-up) provisions and the interplay of dispute resolution mechanisms in a purchase agreement.

The case involved a merger between two companies in the disease management and wellness business, Matria and CorSolutions. Apparently, before the closing CorSolutions received some complaints from a key customer about their bill and failed to disclose that to the buyer. Matria got the call from the customer - one day after closing - and then spent the next six months negotiating what turned into a $4 million settlement. This was done without discussion with the seller and without their consent. After the settlement, Matria sought relief from the seller for their payment and the dispute ensued.

To complicate things, this agreement had four different types of dispute and resolution mechanisms, two of which are relevant here. The first was a typical post closing adjustment (true up) provision relating to balance sheet adjustments for things like working capital, cash on hand, indebtedness, etc. Disputes arising from adjustments would be submitted to an outside accountant (a “Settlement Accountant”). These claims were not limited by a cap and would be adjusted on a first dollar basis.

Other claims by the parties relating to the transaction, such those arising from breaches of representations, warranties or covenants, would be handled by a AAA arbitration. These claims would be resolved against a $20 million escrow fund, and were subject to a basket (i.e. deductible) of $4.5 million. The agreement also provided a typical exclusive remedy clause where all claims other than fraud or for injunctive relief would be limited to the escrow fund.

The court noted that, in anticipation of a potential hierarchy issue stemming from the different ADR provisions, the parties also provided that any claim that could be brought related to the financial statement adjustments will be subject to that provision and not subject to the escrow fund. ("The items set forth on or reflected in the [financial statements delivered in connection with the true-up] and any matters relating thereto that could have been subject to adjustment or dispute pursuant to [the true-up] are subject solely to the adjustments set forth in Article II [i.e. by the Settlement Accountant] . . . and accordingly shall not be subject to any claim by [Matria]… on the Escrow Fund.”)

If the claim went before the Settlement Accountant, Matria may recover fully on its $4 million claim; if it goes before the AAA, they will likely get nothing since it will be wiped out by the $4.5 million basket. Therefore, it is not surprising that the parties could not agree on the forum.

The interesting part of this decision is the analysis of how Matria’s claim arising from the customer complaint could be characterized under the agreement. The Court noted that the claim could be (1) a potential claim, serious enough to be reflected on CorSolutions’ balance sheet, and therefore properly before the Settlement Account on a first dollar basis; (2) a misrepresentation based on a failure to disclose and a breach of various representations and warranties and, thus properly before the AAA and subject to the cap and basket ; and (3) a Third-Party Claim pursued by the customer, where yet a third mechanism from indemnity and damage relief would apply. The discussion appears on pp. 15-16 of the decision.

At the end of the day, the court being predominately known for its strict construction, directed the dispute to the Settlement Accountant on the basis of the hierarchy clause that was in the agreement, albeit with some reluctance. (“The result reached here is, in large part, unpalatable; it is the product, however, of words chosen by sophisticated parties who drafted a complex and comprehensive agreement. More importantly, it is not for some judge to substitute his subjective view of what makes sense for the terms accepted by the parties.”).

The moral of the story here is that these are very complex provisions that really need to be tested by the drafters in advance to make sure that they will work in the field. The Matria decision has a lot of other interesting nuggets for transactional lawyers relating to arbitrability, contract constuction and drafting examples (that may or may not work, depending on one's viewpoint) and therefore worth a closer a read.