The Delaware Chancery Court recently decided a case of first impression that may have ongoing ramifications for venture capital financing transactions. In Latesco L.P. v. Wayport Inc., Del Ch., C.A. No. 4167-VCL, the court was called on to decide what, if any, disclosures are required when a right of first refusal is exercised by an insider of a privately held company. As discussed in more detail below, the court decided that when an insider exercises a contractual right of first refusal and purchases shares from a minority stockholder strictly pursuant to the terms of the right of first refusal, the terms of the right of first refusal agreement govern the disclosure requirements.
However, when an insider engages in an acquisition transaction with a minority stockholder that is not subject to a right of first refusal agreement, the insider must disclose to the minority stockholder any material information known by such insider to be unavailable to the minority stockholder.
A. The Case.
In 2000, Brett Stewart, his spouse and other Wayport Inc. ("Wayport") founders entered into a right of first refusal and co-sale agreement (the "Rights Agreement") that subjected the transfer of their Wayport shares to a right of first refusal initially in favor of Wayport and then, to the extent not exercised, in favor of the other parties to the Rights Agreement. In addition to being one of the founders of Wayport, Stewart developed much of Wayport's intellectual property and served as its founding CEO and as a board member.
Several years later in 2006, when Stewart was no longer an insider, an outside third party offered to purchase 300,000 shares of Stewart's Wayport stock for $3.00 per share. Stewart complied with the Rights Agreement and offered the shares to Wayport. When Wayport declined to purchase the shares, Trellis Partners Opportunity Fund LP ("Trellis") and New Enterprises Associates ("NEA"), both of whom had either a board representative or board observation rights, had the right to purchase the shares. When Trellis and NEA declined to purchase the shares, the shares were sold to the third party. Subsequent to the first sale, the third party offered to purchase additional shares from Stewart at a purchase price of $2.50 per share. Again, Stewart complied with the Rights Agreement. This time, there was some confusion as to which version of the Rights Agreement was in effect. The Rights Agreement signed in 2000 was the Third Amended and Restated Right of First Refusal and Co-Sale Agreement and was signed by all parties. The Rights Agreement was later amended, but Stewart and his wife never signed that amendment or any other version. As a result, Chuck Williams, Wayport's General Counsel and a director, requested that Stewart also offer additional shares to Wayport, the directors, Trellis and NEA in excess of the shares the third party was offering to purchase from Stewart. While Wayport and the directors did not purchase shares from Stewart during the second sales transaction, Trellis and NEA purchased 148,000 and 350,000 shares, respectively.
During each sales transaction, Stewart requested information regarding the operations of Wayport. Wayport did make available limited information regarding its financial results. The Rights Agreement did not address whether Stewart had a right to access Wayport information in connection with a sale of his stock, and the information was provided only after Stewart threatened to file suit under the Delaware General Corporation Law Section 220 which provides that stockholders are entitled to inspect the books and records of a corporation upon request. During the second sales transaction in particular, Stewart allegedly expressed concern to Williams that as an outsider, he did not have access to the same information as insiders like Trellis and NEA because he did not have a representative on the board or board observation rights. During the negotiations for the second sales transaction, the Trellis representative director sent Stewart an email stating that " [w]e are not aware of any bluebirds of happiness in the Wayport world right now and have graciously offered to rep that."  Stewart attempted to obtain a representation regarding this issue in the purchase documents, but no such representation was included.
After the second sale was concluded, Stewart found out that Cisco Systems Inc. had, prior to the "no bluebirds of happiness" email, expressed an interest in buying at least one of Wayport's patents for $9.5 million, which purchase subsequently closed. A little over a year later on November 6, 2008, Wayport announced that it had reached an agreement to sell the company to AT&T for $328 million (approximately $6.43 per share of common stock).
B. The Claims.
On November 17, 2008 Stewart filed suit against Wayport, Trellis, NEA, the directors and Chuck Williams for, among other claims, breach of the fiduciary duty of disclosure; breach of the fiduciary duty of loyalty; and fraudulent misrepresentation. The defendants moved to dismiss the claims and oral argument was heard on June 11, 2009.
Stewart's general argument was that, as insiders, the defendants owed Stewart, a minority stockholder, a general fiduciary duty to disclose the pending patent sale to Cisco and that the failure to do so constituted a breach of their fiduciary duties of loyalty and disclosure and constituted fraud. While there is no allegation that any of the defendants were aware of the impending AT&T transaction at the time of the second sales transaction, Stewart used the information as evidence to show that AT&T valued the intellectual property of Wayport to be in excess of the $2.50 price Stewart received for his shares and that therefore given the Cisco valuation of what Stewart argued was the least valuable patent and the final price paid for the whole company, the insiders had information about the value of the shares that was not disclosed to him in a breach of their fiduciary duties. The defendants claim that the terms of the right of first refusal in the Rights Agreement governed what disclosures, if any, they were required to make and that, as a result, they were free to exercise the right of first refusal without disclosing the potential patent sale.
C. The Holding.
The court, in dismissing most of the claims, held that the performance of a stockholder agreement such as the Rights Agreement giving the corporation or insiders a right of first refusal is not governed by any generalized fiduciary duties of disclosure or loyalty and the "contours of such insider's duty to the selling stockholder is defined by the terms of the agreement itself and normal prohibitions against fraud." However, the court found that because the second sales transaction included the sale of shares beyond the amount required to be offered pursuant to the Rights Agreement, the entire second sales transaction fell outside the contours of the Rights Agreement that actually was binding on the Stewart. As a result, since the transactions were made outside of the confines of a stockholders agreement, the court found that the insiders remained subject to normal obligations of fiduciaries either to not to engage in transactions with stockholders while in possession of material information known to be unavailable to the selling stockholders or to disclose such information to the selling stockholder.
D. Holding Analysis.
The court agreed with the plaintiff that as a general rule under Delaware law, a corporation's directors, as fiduciaries of the stockholders, are subject to a fiduciary duty of disclosure and a fiduciary duty of loyalty to the corporation's stockholders. The fiduciary duty of disclosure and the fiduciary duty of loyalty are similar in that they are both based on principles of honesty and fair dealing towards stockholders; however, the fiduciary duty of disclosure applies only when there has been a general call to stockholder action by the corporation acting through its directors. For example, if all the stockholders are being asked to make a decision (such as vote or tender their shares), the directors have a fiduciary duty to disclose all material information regarding the decision being presented because it would be impossible for all the stockholders to ask and have answered all their questions. However, the court continued, if individual stockholders are asked to engage in a purchase or sale, the fiduciary duty of disclosure does not apply because the stockholder could simply not conclude the sale until it has been provided with all the information it desires. In such a transaction, the fiduciaries are still subject to the underlying duty of loyalty. 
The relevant facts in this case did not support a breach of fiduciary duty to disclose claim because there was no general call to stockholder action. In the court's analysis, the Rights Agreement was typical of most rights agreements. Therefore, a general fiduciary duty to disclose does not apply in this case because, as is generally the case with the exercise of rights of first refusal, the parties had a contractually bargained for right; none of Wayport, the directors or the insiders initiated or requested the sale of the stock; and none of Wayport, the directors or the insiders had the ability to negotiate the price to be paid for the stock. Furthermore, because the Rights Agreement, like most rights of first refusal agreements, did not include provisions with respect to the type of disclosure that must be made during the exercise, Stewart, like most selling stockholders, should have been aware from the time that he signed the stockholder agreement that once he was not an insider, he would have to make the decision of whether to sell or not to sell to the insiders based on asymmetrical information. As a result, the court decided that it should observe the terms of the Rights Agreement and not read into the contract fiduciary duties of disclosure and loyalty that were not negotiated for at the time that the contract was signed.
As discussed above, the court distinguished the second sales transaction from the first sales transaction because the second sales transaction provided for the sale of additional shares of stock at the request of the General Counsel. The court found that these shares were not, in fact, covered by the Rights Agreement and, as a result, the General Counsel wrongly requested that the additional shares should be offered pursuant thereto. Thus, the second sales transaction was not governed by the terms of the Rights Agreement. Because the second sale took place outside of the terms of a right of first refusal agreement, the second sale was evaluated under the normal standards for determining a breach of the duty of loyalty and of fraud as applied between insiders and minority stockholders.
With respect to Stewart's claim of a breach of the fiduciary duty of loyalty, the court stated that the general fiduciary duty of loyalty principles also applied. Trellis, NEA and Williams, as insiders privy to material information, had a duty, when communicating with Stewart, to communicate with candor and not to make false statements or otherwise materially misrepresent facts. The court noted that it assumed that Trellis and NEA were aware, by virtue of their board representation/observer, of the patent sale at the time that they entered into the second sales transactions with Stewart, and that by virtue of the possession of such inside information they constituted constructive insiders with concomitant fiduciary duties. Because Trellis, NEA and Williams purchased or participated in the purchase of the stock from Stewart while in possession of material information which they did not disclose to Stewart, they breached their fiduciary duties of loyalty to Stewart, a minority stockholder.
With respect to the fraud claim, the standard of evaluation is a scienter based standard that, in the case of a fiduciary, may include a duty to speak when the fiduciary is aware that material information is known to the fiduciary that is not known by the counterparty to the transaction. The court assumed that, as insiders, Trellis, NEA and Williams knew of the Cisco transaction at the time of the second sales transaction and thus knew that their failure to speak would imply a false misrepresentation. As insiders with fiduciary duties to speak, their failure to speak satisfied the scienter element of the fraud claim, and the fraud claim was sustained.
We believe that this case clarifies what disclosure obligations insiders may have to minority stockholders when communicating with stockholders in the context of a sale or tender of stock in a privately held company. With respect to the disclosure obligations of insiders, the case holds that if the insiders are buying shares from a minority stockholder pursuant to the terms of a right of first refusal, then neither the general fiduciary duty of disclosure nor the general duty of loyalty applies to the insiders. Rather, the terms of any required disclosure are to be specified in the right of first refusal contract. However, if the insiders are buying shares from a minority stockholder outside of the terms of a contractual right of first refusal, the duty of loyalty applies, and, therefore, the insiders have a duty not to engage in a transaction with such stockholder while in possession of material information known to be unavailable to the selling stockholder.
Therefore, when drafting rights of first refusal, each party's disclosure obligations and rights upon the exercise of the right of first refusal should be specified in the right of first refusal agreement. Such provisions, if included, should specifically set forth the disclosure obligations of the insiders as well as the information rights of the minority stockholders. To the extent any party anticipates that it may someday not be an insider when it is still subject to a Rights Agreement, then such party should ensure that the documents contain disclosure requirements and information rights.
When the right of first refusal is being exercised, the attorneys for the selling party should ensure that the purchase agreement contains representations that all material information known to the insiders as of the closing date has been disclosed to the selling stockholder.
If a corporation (acting through its directors) is soliciting an action from all the stockholders that is not pursuant to a pre-negotiated contract, such as a buyback of shares from the stockholders, the corporation's directors, officers and controlling stockholders should be mindful that they do have a fiduciary duty to disclose all material information to the stockholders. Directors must carefully review the disclosure document with the corporation's counsel to ensure that all information that could be considered material is included in the disclosure document. We also recommend that the tender documentation contain a representation that all parties understand the risks of the transaction and have been provided a chance to conduct diligence and are satisfied with the results of the diligence. 
John Hempill, Partner, email@example.com
John Hempill acts as general outside counsel for a number of privately and publicly held companies in a variety of industries. He has extensive experience in private and public finance, ranging from representing private emerging growth companies, venture capital funds and strategic investors in seed rounds and later stage private financings, to representing public companies and investment banks in public offerings, as well as 144A and PIPEs financings.
Mr. Hempill is also an experienced mergers and acquisitions lawyer for both public and private companies, having advised clients in acquisitions and dispositions of assets, as well as in other types of negotiated business combinations. He has represented venture capital and other funds in their formation and capitalization. His practice also involves negotiating and documenting strategic alliances and joint ventures, and providing advice on corporate governance as well as SEC and stock market regulations for public companies.
Alexis Coppedge, Associate, firstname.lastname@example.org
Alexis Coppedge is an associate in the firm's New York office and practices in the Corporate Group of the Business Department.
Ms. Coppedge's practice focuses on mergers and acquisitions, securities, and financing law. Her practice encompasses a broad range of domestic and international transactions, including cross-border mergers and acquisitions, venture capital finance, project finance, acquisition finance, and joint venture arrangements.
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 The term "insider" is used throughout this article in the same manner as the term "insider" is used by the court. Specifically, the court defined an "insider" as a stockholder party that by virtue of board of director representation or the right to observe the board of directors possesses additional information about a company beyond what is made available to other stockholders.
 Latesco L.P. is the corporate vehicle through which Stewart and his wife claim to have beneficial ownership of additional shares of Wayport stock.
 Latesco at õI.B.2 p. 8
 Latesco at p.2
 The court notes that the basic test for materiality is the test established in Basic v. Levinson, 485 U.S. 224 (1988) that materiality will "depend at any given time upon a balancing of both the indicated probability that the event will occur and the anticipated magnitude of the even in light of the totality of the company activity." We presume that the definition of "materiality" as defined in other Delaware case law would also be applicable in this instance. Specifically, that a fact is material if there exists "a substantial likelihood that a reasonable stockholder would consider the information important in deciding whether to sell, tender or hold shares." TSC Indus., Inc. v. Northway 426 U.S. 438 (1976).
 The duty of loyalty generally requires that fiduciaries deal candidly and fairly with the company and its stockholders; not engage in self dealing with the company; not be motivated by self interest in their work for the company; and not make false statements or otherwise materially misrepresent facts in such a way as to defraud the company or the stockholders. Note that the duty does not go so far as to guarantee all stockholders equal information rights or impose a duty on directors to ensure that all stockholders have equal access to information.
 Delaware courts have held that the duty of candor is one of the elementary principles of fair dealing and that such fiduciary duty is imputed not only to officers and directors, but to all persons who are privy to material information obtained in the course of representing a company (see Mills Acquisition Co. v. Macmillan, Inc. 559 A. 2d 1261 (Del. 1989).
 This is in contrast to the affirmative misrepresentation or intentional concealment species of fraud which Stewart would be restricted to pleading if the second sales transaction fell with the scope of the right of first refusal.
 The remaining elements of a the fraud claim, which are not discussed here, were also satisfied.
 An example of such a representation could be as follows: "During the negotiation of the transactions contemplated herein, the [seller] and its representatives have been afforded full and free access to corporate books, financial statements, records, contracts, documents, and other information concerning the Company and to the offices and facilities of the Company, have been afforded an opportunity to ask such questions of the officers and employees of the Company concerning the business, operations, financial condition, assets, liabilities and other relevant matters of the Company as they have deemed necessary or desirable, and have been given all such information as has been requested, in order to evaluate the merits and risks of the prospective sale contemplated herein."