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Rethinking Rule 14a-8: A Case for Repeal or Meaningful Reform of the Shareholder Proposal Rule

The shareholder proposal rule, Securities Exchange Act Rule 14a-8, has long been heralded as a democratizing tool in corporate governance, allowing shareholders to voice their concerns through inclusion in company proxy materials. While well-intentioned, Rule 14a-8 is no longer fit for purpose. The rule imposes disproportionate costs on issuers, enables misuse by a small group of activists, and distracts boards from their core fiduciary responsibilities. Attempts at reform have failed to address these systemic flaws. This article argues that Rule 14a-8 should be repealed entirely or, at a minimum, reformed to align with its original purpose while restoring balance to corporate governance.

The History and Evolution of Rule 14a-8

When Congress enacted the Securities Exchange Act of 1934, it delegated substantial authority to the Securities and Exchange Commission (SEC) to regulate proxy solicitation under § 14(a). In 1942, the SEC adopted Rule 14a-8, allowing shareholders to submit proposals for inclusion in company proxy materials, provided the proposals were proper subjects for shareholder action under state law. Over the decades, the rule has been amended repeatedly, expanding both its procedural and substantive reach.

Initially envisioned as a mechanism to enhance shareholder participation, Rule 14a-8 has instead evolved into a tool for a minority of activists to advance agendas often unrelated to the company’s financial performance. This evolution has come at a cost: growing procedural complexity, increased compliance burdens, and the diversion of board attention from strategic priorities.

Flaws in the Current Rule

High Costs and Burdens. The financial and administrative costs associated with Rule 14a-8 are significant. Estimates suggest that a single shareholder proposal can cost a company as much as $150,000 in direct expenses, not including the considerable time and effort required to manage the process. For many companies, these costs disproportionately benefit a small minority of shareholders while providing little value to the broader shareholder base.

Misuse by Activists. Rule 14a-8 is disproportionately utilized by a handful of "corporate gadflies," who submit proposals on personal, political, or social issues rather than matters of economic importance to the company. For instance, data indicate that a mere three individuals or groups account for a substantial portion of shareholder proposals submitted annually.

Moreover, union pension funds and other institutional investors often leverage the rule to advance private agendas, such as labor disputes or political initiatives, rather than promoting shareholder value. These practices deviate from the rule's intended purpose and impose additional costs on the majority of shareholders.

Distraction from Core Responsibilities. Rule 14a-8 also undermines board primacy by forcing directors to engage with proposals that delve into operational matters traditionally reserved for management. This distraction erodes the business judgment rule's protections and detracts from boards' focus on long-term value creation.

Arguments for Repeal

Restoring Board Autonomy. Repealing Rule 14a-8 would reaffirm the primacy of the board of directors in corporate governance. Directors are better positioned than shareholders to make informed decisions on operational and strategic matters. Eliminating the rule would allow boards to focus on their fiduciary duties without the procedural distractions imposed by frivolous or ideological proposals.

Encouraging Efficient Governance. Without Rule 14a-8, companies could allocate resources more effectively, investing in initiatives that directly contribute to shareholder value. The elimination of costly and time-consuming proposal processes would free management to address substantive business concerns.

Aligning Corporate Governance with State Law. Corporate governance is traditionally the domain of state law, which emphasizes the contractual nature of corporate charters and bylaws. Rule 14a-8’s federal overlay disrupts this framework, imposing uniform requirements that often conflict with state-level governance principles. Repeal would restore the balance between federal and state authority in corporate governance.

Proposals for Meaningful Reform

If outright repeal is deemed impractical, significant reforms should be implemented to mitigate the flaws in Rule 14a-8.

Raising Eligibility Thresholds. The Rule currently provides that a proponent must have held “(A) At least $2,000 in market value of the company's securities entitled to vote on the proposal for at least three years; or (B) At least $15,000 in market value of the company's securities entitled to vote on the proposal for at least two years; or (C) At least $25,000 in market value of the company's securities entitled to vote on the proposal for at least one year.” These ownership thresholds are outdated and fail to ensure that proposal proponents have a meaningful economic stake in the company. Increasing the threshold to a scalable percentage of company value or a significantly higher dollar amount, such as $200,000, would deter frivolous proposals.

Lengthening Holding Periods. Requiring shareholders to hold their positions for at least three years without regard for the amount of stock they own, rather than the current tiered periods, would ensure that proposals come from long-term investors genuinely committed to the company’s success.

Narrowing the Scope of Eligible Proposals. Rule 14a-8(i)(5) should be amended to limit proposals to matters of material economic significance. The Rule currently permits a company to exclude a proposal that “relates to operations which account for less than 5 percent of the company’s total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company’s business.”

Activists seized on the "not otherwise significantly related" language to argue that proposals with ethical and social significance should not be excludable even if they had no substantial economic significance. The courts and the SEC agreed. But mere ethical or social significance in the air should not be enough. Adopting a materiality standard aligned with federal securities law would prevent the inclusion of proposals addressing social or political issues unrelated to the company’s business.

The SEC should ask whether a reasonable shareholder of this issuer would regard the proposal as having material economic importance for the value of his shares. This standard is based on the well-established securities law principle of materiality. It is intended to exclude proposals made primarily for the purpose of promoting general social and political causes, while requiring inclusion of proposals a reasonable investor would believe are relevant to the value of his investment. Such a test seems desirable so as to ensure that an adopted proposal redounds to the benefit of all shareholders, not just those who share the political and social views of the proponent. Absent such a standard, the shareholder proposal rule becomes nothing less than a species of private eminent domain by which the federal government allows a small minority to appropriate someone else’s property—the company is a legal person, after all, and it is the company’s proxy statement at issue—for use as a soapbox to disseminate their views. 

Strengthening the "Ordinary Business" Exclusion. The Rule 14a-8(i)(7) exclusion allows companies to omit proposals related to ordinary business operations. Unfortunately, court and SEC decisions have largely eviscerated the ordinary business operations exclusion. Corporate decisions involving “matters which have significant policy, economic or other implications inherent in them” may not be excluded as ordinary business matters, for example, which creates a gap through which countless proposals have made it onto corporate proxy statements. As a result, the exclusion no longer fulfills its core function of preventing shareholders from micromanaging the company. The exclusion thus should be revitalized to empower boards to exclude proposals that intrude on management’s operational prerogatives.

Allowing Corporations to Opt Out. Finally, companies should be permitted to opt out of Rule 14a-8 through shareholder-approved charter amendments. This approach would respect shareholder preferences while reducing regulatory burdens.

Addressing Counterarguments

Critics of repeal or reform often argue that Rule 14a-8 is essential for holding boards accountable and providing shareholders with a voice. However, alternative mechanisms, such as direct engagement with management, annual meetings, and state-law remedies, can serve these functions without the inefficiencies associated with the current rule. Moreover, reforms like higher thresholds and longer holding periods would preserve shareholder oversight while minimizing abuse.

Conclusion

Rule 14a-8 has outlived its usefulness. Its costs, procedural inefficiencies, and susceptibility to misuse outweigh its benefits, particularly in a modern corporate governance environment where other tools for shareholder engagement exist. Repealing the rule would restore balance to corporate governance, empowering boards to focus on their fiduciary responsibilities and long-term value creation. If repeal proves politically unfeasible, meaningful reforms—such as higher ownership thresholds, stricter materiality standards, and revitalized exclusions—must be implemented to align the rule with its intended purpose.

By embracing either repeal or robust reform, policymakers can ensure that corporate governance evolves to meet the needs of modern shareholders and issuers alike.

A critique of SEC Commissioner Caroline Crenshaw's statement opposing Staff Bulletin 14M and defending the broken shareholder proposal regime

Predictably, Democratic SEC Commissioner Caroline Crenshaw opposed the important and timely SEC Staff Bulletin updating the way the SEC applies the economic significance and ordinary business exclusions to the shareholder proposal rule. I discussed the new bulletin in the prior post.

In this post, I reply to some of the claims Crenshaw makes trying to defend the indefensible.

Crenshaw repeatedly says this is a political decision: 

This type of political policy shifting mid-season serves to undercut capital formation, not facilitate it.

The rescission comes as no surprise given that the shareholder proposal process has become the target of politicized messaging ...

We are so focused on undoing the prior Commission’s agenda that we sow chaos now. 

... this leadership has rushed out staff guidance for the sake of political expediency

Elections have consequences. More important, the shareholder proposal rule has become politicized precisely because for the past several decades it has been a tool almost exclusively used by either gadflies or progressive political interest groups to advance an agenda unshared by their fellow investors. It is Crenshaw's political sponsors who have brought us to this point by turning the proposal rule into a soapbox paid for by investors at large.

True, it has finally been the case that some conservative activists are using the proposal rule to advance their agenda. (As far back as 2004, I wondered why they ignored this potential communication medium.) Not that they had much luck under Gensler.

In any case, while I acknowledge that what is sauce for the goose should also be sauce for the gander, I would prefer that no activists of any political stripe be able to abuse the rule as they have done.

Crenshaw also says that the rule has become "a  preferred punching bag of those who wish to diminish corporate democracy."

Sigh.

There is no such thing as corporate democracy. 

Just as a large city cannot be run as a New England town meeting, a large corporation is a poor candidate for direct democracy. There simply are too many widely dispersed shareholders who have varying degrees of information about the company, differing goals and investment time horizons, and competing ideas about optimal business practices for their preferences to be aggregated efficiently. Accordingly, state corporate law traditionally has given primary decision-making authority to the board and the managers to whom the board properly delegates authority. As the Delaware General Corporation Law puts it, the “business and affairs” of a corporation “shall be managed by or under the direction of a board of directors.”

Stephen M. Bainbridge, Revitalizing SEC Rule 14a-8's Ordinary Business Exclusion: Preventing Shareholder Micromanagement by Proposal, 85 Fordham L. Rev. 705, 707–08 (2016). Put simply, democracy is not an appropriate metaphor for corporate governance. It thus cannot serve as a justification for the shareholder proposal rule.

Finally, Crenshaw complains that the new bulletin will allow exclusion of "topics relating to poison pills, compensation, emerging issues such as AI, political and lobbying expenditures, and environmental or other issues that shareholders have identified as materially impacting the firm’s financial value." (My emphasis.)

I call BS. These are not topics that investors have identified as materially impacting the firm’s financial value.

How do I know? Because proposals advanced by leftwing activists relating to those proposals almost always fail to receive majority support. In a 2003 Barrons op-ed, for example, I wrote that:

Recent SEC guidance allowing more proposals dealing with broad societal issues to be considered has led to a significant increase in the number of shareholder proposals centered on political questions. But while the SEC insists that investors are demanding these changes, shareholders are increasingly rejecting proposals dealing with social issues. In fact, in 2023, support for ESG-related proposals fell to just 22% on average, a decline of 11 percentage points since 2021.

ExxonMobil, Chevron, JP Morgan, and Goldman Sachs all defeated proposals that would require the companies to disclose their absolute emissions data rather than carbon intensity metrics, Bloomberg Law recently reported. ...

As I explained in my recent book, The Profit Motive, most investors still care mainly about maximizing value rather than advancing partisan agendas.

In thinking about Crenshaw's statement I couldn't help but recall a Friends episode in which Russ told Ross "You could not be more wrong. You could try but you would not be successful."

Acting SEC Chair puts long needed limits on shareholder activism via proposals

Last week the SEC issued Staff Legal Bulletin No. 14M. It makes some key changes in how the SEC will apply the shareholder proposal rule during the current proxy season.

In brief, the shareholder proposal rule (SEC Rule 14a-8) allows shareholders to submit proposals for inclusion in company proxy materials, provided the proposals are proper subjects for shareholder action under state law.

Initially envisioned as a mechanism to enhance shareholder participation, Rule 14a-8 has instead evolved into a tool for a minority of activists to advance agendas often unrelated to the company’s financial performance. This evolution has come at a cost: growing procedural complexity, increased compliance burdens, and the diversion of board attention from strategic priorities.

Rule 14a-8 is disproportionately utilized by a handful of "corporate gadflies," who submit proposals on personal, political, or social issues rather than matters of economic importance to the company. For instance, data indicate that a mere three individuals or groups account for a substantial portion of shareholder proposals submitted annually.

Moreover, union pension funds and other institutional investors often leverage the rule to advance private agendas, such as labor disputes or political initiatives, rather than promoting shareholder value. These practices deviate from the rule's intended purpose and impose additional costs on the majority of shareholders.

Rule 14a-8 also undermines board primacy by forcing directors to engage with proposals that delve into operational matters traditionally reserved for management. This distraction erodes the business judgment rule's protections and detracts from boards' focus on long-term value creation.

There are a number of grounds on which management can refuse to include a proposal. Two are particularly significant at the moment.

The first is the exclusion for proposals lacking economic significance. It permits a company to exclude a proposal that “relates to operations which account for less than 5 percent of the company’s total assets at the end of its most recent fiscal year, and for less than 5 percent of its net earnings and gross sales for its most recent fiscal year, and is not otherwise significantly related to the company’s business.”

Activists seized on the "not otherwise significantly related" language to argue that proposals with ethical and social significance should not be excludable even if they had no substantial economic significance. The courts and the SEC under liberal administrations agreed. In recent years, under the execrable Gary Gensler, progressive proposals lacking any meaningful nexus to the company's business have been waved through by the SEC.

Not anymore:

The Division’s analysis will focus on a proposal’s significance to the company’s business when it otherwise relates to operations that account for less than 5% of total assets, net earnings and gross sales. Under this framework, proposals that raise issues of social or ethical significance may be excludable, notwithstanding their importance in the abstract, based on the application and analysis of each of the factors of Rule 14a-8(i)(5) in determining the proposal’s relevance to the company’s business.

Because the rule allows exclusion only when the matter is not “otherwise significantly related to the company,” we view the analysis as dependent upon the particular circumstances of the company to which the proposal is submitted. That is, a matter significant to one company may not be significant to another.  ...

... The proponent could continue to raise social or ethical issues in its arguments, but in accordance with these Commission statements it would need to tie those matters to a significant effect on the company’s business. The mere possibility of reputational or economic harm alone will not demonstrate that a proposal is “otherwise significantly related to the company’s business.” 

I suggest that in applying this standard that the SEC should ask whether a reasonable shareholder of this issuer would regard the proposal as having material economic importance for the value of his shares. This standard is based on the well-established securities law principle of materiality. It is intended to exclude proposals made primarily for the purpose of promoting general social and political causes, while requiring inclusion of proposals a reasonable investor would believe are relevant to the value of his investment. Such a test seems desirable so as to ensure that an adopted proposal redounds to the benefit of all shareholders, not just those who share the political and social views of the proponent. Absent such a standard, the shareholder proposal rule becomes nothing less than a species of private eminent domain by which the federal government allows a small minority to appropriate someone else’s property—the company is a legal person, after all, and it is the company’s proxy statement at issue—for use as a soapbox to disseminate their views. 

The other is where the proposal speaks to the ordinary business of the company (Rule 14a-8(i)(7)).

As I explained in my article, Revitalizing SEC Rule 14a-8's Ordinary Business Exemption: Preventing Shareholder Micromanagement by Proposal, Rule 14a-8(i)(7) raises fundamental issues of corporate governance:

Who decides what products a company should sell, what prices it should charge, and so on? Is it the board of directors, the top management team, or the shareholders? In large corporations, of course, the answer is the top management team operating under the supervision of the board. As for the shareholders, they traditionally have had no role in these sort of operational decisions. In recent years, however, shareholders have increasingly used SEC Exchange Act Rule 14a-8 (the so-called shareholder proposal rule), to not just manage but even micromanage corporate decisions.

The rule permits a qualifying shareholder of a public corporation registered with the SEC to force the company to include a resolution and supporting statement in the company’s proxy materials for its annual meeting. In theory, Rule 14a-8 contains limits on shareholder micro-management. The rule permits management to exclude proposals on a number of both technical and substantive bases, of which the exclusion in Rule 14a-8(i)(7) of proposals relating to ordinary business operations is the most pertinent for present purposes. Rule 14a-8(i)(7) is intended to permit exclusion of a proposal that “seeks to ‘micro-manage’ the company by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment.”

Unfortunately, court decisions have largely eviscerated the ordinary business operations exclusion. Corporate decisions involving “matters which have significant policy, economic or other implications inherent in them” may not be excluded as ordinary business matters, for example, which creates a gap through which countless proposals have made it onto corporate proxy statements.

In effect, the exclusion no longer fulfills its core function of preventing shareholders from micromanaging the company.

The new staff bulletin goes at least part of the way towards giving the exclusion teeth.

... the staff will take a company-specific approach in evaluating significance, rather than focusing solely on whether a proposal raises a policy issue with broad societal impact or whether particular issues or categories of issues are universally “significant.” Accordingly, a policy issue that is significant to one company may not be significant to another. The Division’s analysis will focus on whether the proposal deals with a matter relating to an individual company’s ordinary business operations or raises a policy issue that transcends the individual company’s ordinary business operations.

The new staff bulletin also reinstates two Trump 1.0 era staff bulletins on the exclusion that Gensler gutted. Both speak to the micromanagement issue. Bulletin 14J stated:

... a proposal may probe too deeply into matters of a complex nature if it “involves intricate detail, or seeks to impose specific time-frames or methods for implementing complex policies.”

A proposal thus can be excluded if it:

“micromanages” the company “by probing too deeply into matters of a complex nature upon which shareholders, as a group, would not be in a position to make an informed judgment.”

Importantly, the bulletin made clear that a standard activist technique to end run the exclusion would no longer work:

This framework also applies to proposals that call for a study or report. For example, a proposal that seeks an intricately detailed study or report may be excluded on micromanagement grounds.

Bulletin 14K provided that:

In the past, proponents and companies have often focused on the overall significance of the policy issue raised by the proposal, instead of whether the proposal raises a policy issue that transcends the particular company’s ordinary business operations. The staff takes a company-specific approach in evaluating significance, rather than recognizing particular issues or categories of issues as universally “significant.” Accordingly, a policy issue that is significant to one company may not be significant to another.

... we believe the focus of an argument for exclusion under Rule 14a-8(i)(7) should be on whether the proposal deals with a matter relating to that company’s ordinary business operations or raises a policy issue that transcends that company’s ordinary business operations. When a proposal raises a policy issue that appears to be significant, a company’s no-action request should focus on the significance of the issue to that company.

In sum, the new bulletin is a good start. It addresses some key problem areas that have allowed activist shareholders to use the rule to advance social proposals largely unrelated to the business of the company.

More needs to be done. But that is a story for another post.

Corporate Directors Can't Change the Rules in the Middle of the Game

Ann Lipton reports on an interetsing new case:

Daktronics is incorporated in South Dakota of all places (is it lonely there?).  South Dakota mandates cumulative voting, which makes it much, much easier for a minority blockholder to gain board representation, as Matt Levine explains here.

And such a blockholder has emerged, in the form of Alta Fox.  Alta Fox is both a shareholder and a holder of Daktronics notes, but the notes are convertible into shares, so on a fully diluted basis, Alta Fox owns over 11% of Daktronics’ voting power.  Given that, at least some of Alta Fox’s director nominees would likely have been seated in a proxy contest but – plot twist! – Daktronics called a special meeting of its shareholders to vote on reincorporation to Delaware, where cumulative voting is not the default.

And, as I understand it, Daktronics is calling for that vote before Alta Fox’s shares convert, so that Alta Fox will be heading into the meeting with less than its full voting power. In response, Alta Fox filed a lawsuit (in federal court, presumably because it just likes the judges and/or procedures better), alleging that Daktronics’s proposal represents a breach of fiduciary duty and shareholder oppression.

Ann points out that the reincorporation "is intended to thwart shareholder voting rights in the context of a particular, threatened proxy contest."

Like Ann, I don't know what specific South Dakota law says, but general corporate law principles says you can't change the rules of the game in the middle of an election contest. From my book Corporate Law:

This effect is nicely illustrated by Coalition to Advocate Public Utility Responsibility, Inc. v. Engels.[1] Northern States Power Company (NSP) had 14 directors, each elected annually for a one-year term by means of cumulative voting. In 1973, CAPUR (a coalition of consumer and environmental groups) sought to elect to the board a “public interest” candidate named Alpha Smaby (really).[2] Smaby promised that, if elected to the board, she would promote the ‘‘public interest” with special concern for environmental and consumer issues. NSP’s board opposed Smaby’s election and sought to prevent it by (1) reducing the number of directors to 12 and (2) classifying the board into three groups of four directors with staggered three-year terms. As a result, only four directors would be up for election in any given year. Under the old rules, Smaby needed the cumulated votes of just over 7% of the shares to be elected. The changes made by the board raised the number of shares needed to assure her election to about 20%.

Both changes were permitted by statute. Most corporate law codes give the board power to make unilateral changes in its size. Most likewise permit the corporation to have a staggered board. The trial court nonetheless granted a preliminary injunction against the board. Why? Because it is inequitable to change the rules in the middle of the game—or so the court opined. Consistent with well-established principles of Delaware law,[3] the court held that otherwise lawful actions can be enjoined as if they unfairly injure rights of minority shareholders. By implementing these changes in the middle of an election campaign, without disclosure, and for the purpose of defeating a minority candidate, the board breached its fiduciary duties. Although the election thus went forward under the old rules, Smaby ultimately did not receive a sufficient number of votes to be elected.[4] The case nevertheless reaffirms the principle that otherwise lawful board action becomes impermissible if undertaken in the midst of an election campaign for the purpose of obstructing a legitimate effort by dissident shareholders to obtain board representation. From the perspective of corporate counsel working with the incumbent directors, of course, the transactional implication is that such changes should be undertaken in mid-year long before any insurgent shareholders begin making noise.

Corporate Directors Can't Change the Rules in the Middle of the Game

Ann Lipton reports on an interetsing new case:

Daktronics is incorporated in South Dakota of all places (is it lonely there?).  South Dakota mandates cumulative voting, which makes it much, much easier for a minority blockholder to gain board representation, as Matt Levine explains here.

And such a blockholder has emerged, in the form of Alta Fox.  Alta Fox is both a shareholder and a holder of Daktronics notes, but the notes are convertible into shares, so on a fully diluted basis, Alta Fox owns over 11% of Daktronics’ voting power.  Given that, at least some of Alta Fox’s director nominees would likely have been seated in a proxy contest but – plot twist! – Daktronics called a special meeting of its shareholders to vote on reincorporation to Delaware, where cumulative voting is not the default.

And, as I understand it, Daktronics is calling for that vote before Alta Fox’s shares convert, so that Alta Fox will be heading into the meeting with less than its full voting power. In response, Alta Fox filed a lawsuit (in federal court, presumably because it just likes the judges and/or procedures better), alleging that Daktronics’s proposal represents a breach of fiduciary duty and shareholder oppression.

Ann points out that the reincorporation "is intended to thwart shareholder voting rights in the context of a particular, threatened proxy contest."

Like Ann, I don't know what specific South Dakota law says, but general corporate law principles says you can't change the rules of the game in the middle of an election contest. From my book Corporate Law:

This effect is nicely illustrated by Coalition to Advocate Public Utility Responsibility, Inc. v. Engels.[1] Northern States Power Company (NSP) had 14 directors, each elected annually for a one-year term by means of cumulative voting. In 1973, CAPUR (a coalition of consumer and environmental groups) sought to elect to the board a “public interest” candidate named Alpha Smaby (really).[2] Smaby promised that, if elected to the board, she would promote the ‘‘public interest” with special concern for environmental and consumer issues. NSP’s board opposed Smaby’s election and sought to prevent it by (1) reducing the number of directors to 12 and (2) classifying the board into three groups of four directors with staggered three-year terms. As a result, only four directors would be up for election in any given year. Under the old rules, Smaby needed the cumulated votes of just over 7% of the shares to be elected. The changes made by the board raised the number of shares needed to assure her election to about 20%.

Both changes were permitted by statute. Most corporate law codes give the board power to make unilateral changes in its size. Most likewise permit the corporation to have a staggered board. The trial court nonetheless granted a preliminary injunction against the board. Why? Because it is inequitable to change the rules in the middle of the game—or so the court opined. Consistent with well-established principles of Delaware law,[3] the court held that otherwise lawful actions can be enjoined as if they unfairly injure rights of minority shareholders. By implementing these changes in the middle of an election campaign, without disclosure, and for the purpose of defeating a minority candidate, the board breached its fiduciary duties. Although the election thus went forward under the old rules, Smaby ultimately did not receive a sufficient number of votes to be elected.[4] The case nevertheless reaffirms the principle that otherwise lawful board action becomes impermissible if undertaken in the midst of an election campaign for the purpose of obstructing a legitimate effort by dissident shareholders to obtain board representation. From the perspective of corporate counsel working with the incumbent directors, of course, the transactional implication is that such changes should be undertaken in mid-year long before any insurgent shareholders begin making noise.

DExit Civil War? The Governor and Legislative Leaders Fire Shots Across Chancery's Bow

Regular readers know that I have been covering the DExit phenomenon. My article  DExit Drivers: Is Delaware's Dominance Threatened?, which is forthcoming in the Journal of Corporation Law, provides empirical data on reincorporations out of Delaware. I concluded that DExit is a trickle not a flood. But I also concluded that there is a class of companies--namely, those with controlling shareholders--that are more likely to think seriously about changing their state of incorporation. As I explain in my other recent article, A Course Correction for Controlling Shareholder Transactions,

Delaware courts increasingly exhibit a reflexive suspicion of transactions involving a controlling shareholder.  The court has operationalized that skepticism by notably broadening the definition of who qualifies as a controlling shareholder. In particular, the courts are increasingly willing to hold that shareholders who own less than a majority of the corporation’s voting power nevertheless possess control.  Taken to its logical extreme, this trend easily could result in someone being deemed a controller even in the absence of stock ownership.  

The court’s growing skepticism of controlling shareholders is further reflected in its tightening of the standards governing the conduct of controlling shareholders.   In doing so, the court has expanded the range of conflicted transactions necessitating cleansing and heightened the rigor with which cleansing standards are applied, particularly regarding the criteria for independent directors. 

The perception that controllers now face a significant risk of liability has prompted companies like Tesla, TripAdvisor, Pershing Square, and Dropbox to leave Delaware. On top of which, Meta announced that is considering do likewise.

I remain unpersuaded that DExit poses a serious threat to Delaware's dominance of the market for corporate charters. The recent high profile departures, however, appear to have freaked out the political class in Delaware. This is not surprising, of course. The annual franchise taxes companies pay Delaware for the privilege of being incorporated there make up as much as 20% of the state's total tax revenue. If that income stream went away because companies incorporated outside Delaware, the state government would either have to make massive budget cuts or raise other taxes dramatically.

Delaware's new Democratic Governor Matt Meyer told Business Insider that DExit must cease:

"It's really important we get it right for Elon Musk or whoever the litigants are in Delaware courts," he said. "We're cognizant that there may be some things that need to change. We're going to work on them."

Though he's been in office for less than two weeks, Meyer said he'd already met with "leading corporate legal brass" and state government leaders to chart a path forward.

"I think within the coming weeks, you're going to see some things rolled out that will help move our state forward and bring us into 2025 and beyond to make sure we're protecting and growing the corporate franchise," he said.

If he's got legislation in mind, might I point out that my article, A Course Correction for Controlling Shareholder Transactions, contains a number of recommendations for legislative reforms but that's another post.

It's not just the Governor, however. Delaware Senator Nicole Poore and Assembly Speaker Melissa Minor-Brown have offered up an op-ed on the importance of Delaware’s dominance of the market for corporate charters in generating tax revenues to fund liberal policies:

We have big goals for the next General Assembly, like adequately funding our education system so every Delaware child can receive a world-class education; expanding affordable housing so that working Delawareans can have a safe place to raise their families and earn an honest living; and improving access to quality and affordable healthcare so we can live healthier lives and make the healthcare system work better for everyone.

None of this will be possible if outside actors are successful in dismantling Delaware’s position as a leader in corporate governance. Discussions of increasing teacher pay, providing tax breaks for hardworking Delawareans and enacting large-scale infrastructure projects could be forced to the back burner as we attempt to navigate budgetary uncertainties. 

... Whether a cut in Medicaid, decreases in law enforcement recruitment or deferred maintenance on roads and bridges, every single Delawarean would be affected by decreased revenue, as we would be forced to make cuts or raise taxes to keep pace with the cost of services our constituents desperately need. 

They go on to call out the Chancery Court for threatening that income stream:

While Delaware's Court of Chancery has remained widely respected for its expertise and fairness, we acknowledge that it’s important to address its lack of diversity and ensure the judiciary reflects the broader perspectives of the communities it serves, thereby enhancing its credibility and fairness, and Delaware’s leadership in corporate governance and justice. 

I don't think they've correctly identified the problem. Instead, as you might expect from my emphasis on the impact of Delaware's conflicted controller caselaw, I think Jonathan Macey correctly diagnosed the problem:

The problem is exacerbated by what are perceived to be the “suspicious and negative tone adopted towards corporate boards and management” by in certain opinions that weaken the contracting power of controlling shareholders and afford legal “protection” to minority and noncontrolling shareholders who neither want nor value the “protections” foisted on them. These protections appear to be unwelcome by controlling shareholders and their advisors who are highly influential in the decision about where to incorporate. Their increasing dissatisfaction with the Delaware legal landscape explains certain of the actual and threatened departures from Delaware. 

Interestingly, yesterday's Delaware Supreme Court decision in the TripAdvisor case reversed one of the prominent cases in which a controller had lost. It calls to mind the switch in time that saved nine. 

Chief Justice Seitz's Defense of Delaware Corporate Law Misses the Point

In a presentation to the PLI Twenty-Second Annual Directors’ Institute on Corporate Governance, Delaware Chief Justice Collins Seitz offers a mostly sensible defense of Delaware corporate law and Delaware's preeminent position in the market for corporate charters. But then he fumbles the main point:

I can hear some of the corporate lawyers in the room groan and say, “Well, what about all those decisions out of Delaware that we have denied business judgment protection for conflict transactions involving controlling stockholders?”

Well, one observation I would make is: most of those transactions foundered on the lack of independence of the special committee or the lack of adequate disclosures about the transaction, meaning the stockholder vote was not fully informed. They failed for lack of compliance with the rules of the road that the Delaware courts have set down.

Had I been in the room, I would have been one of those moaning. My article  DExit Drivers: Is Delaware's Dominance Threatened?, which is forthcoming in the Journal of Corporation Law, provides empirical data on reincorporations out of Delaware. My article explains that controlled companies are the most likely to seek DExit:

Delaware courts have decided a series of recent high profile cases that have raised controller’s liability exposure.  Specifically, in cases “involving Tesla Inc., TripAdvisor Inc., Moelis & Co., and Sears Hometown and Outlet Stores Inc.,” the court has “sought to tighten the standards for conduct by controlling stockholders.”  Areas in which the Chancery Court is perceived to have tightened standards respecting controllers include a broader definition of who is in control, expanding the class of conflicted transactions requiring cleansing, and the strictness with which the standards for cleansing are applied, especially with respect the definition of who is an independent director. . . .

As such, concerns about both the application of the law and the tone of the opinions are mounting. A New York-based corporate law partner observed that uncertainty about the definition of independence is a major concern among those voicing skepticism about the direction of Delaware law.  The same partner noted a growing impression that certain Delaware Chancery Court judges have developed a skeptical attitude towards independence of directors of Silicon Valley firms.  Similar sentiments were expressed by both a prominent Delaware academic and a leading Delaware practitioner.  On her group blog, Professor Ann Lipton likewise speculated that these developments may “hit Silicon Valley companies particularly hard, because of the chumminess of the tech world, and it's not surprising that once independence is questioned, the tone of the opinions is going to come off as skeptical, in a manner that defendants do not like.”

Chief Justice Seitz dismisses these cases by arguing that all would have been well if the controllers had jumped through the prescribed hoops, arguing the controllers lost because of their "lack of compliance with the rules of the road that the Delaware courts have set down."

The trouble, of course, is that the rules of the road that the Delaware courts have set down" make no sense doctrinally or from a policy perspective. My other recent article, A Course Correction for Controlling Shareholder Transactions, argues that:

Delaware courts increasingly exhibit a reflexive suspicion of transactions involving a controlling shareholder.  The court has operationalized that skepticism by notably broadening the definition of who qualifies as a controlling shareholder. In particular, the courts are increasingly willing to hold that shareholders who own less than a majority of the corporation’s voting power nevertheless possess control.  Taken to its logical extreme, this trend easily could result in someone being deemed a controller even in the absence of stock ownership.  

The court’s growing skepticism of controlling shareholders is further reflected in its tightening of the standards governing the conduct of controlling shareholders.   In doing so, the court has expanded the range of conflicted transactions necessitating cleansing and heightened the rigor with which cleansing standards are applied, particularly regarding the criteria for independent directors. 

This article contends that Delaware courts need a course correction. They have pushed the law governing controlling shareholders far beyond legitimate policing into unnecessary and unwise overregulation. This has prompted a backlash in which controllers threaten to reincorporate outside of Delaware, following Elon Musk’s example of moving Tesla to Texas.

Accordingly I propose four corrections:

...  the courts: (1) should narrow the definition of controller; (2) should not attempt to sort out in which cases controllers owe fiduciary duties to the minority from those in which they do not, but instead hold that a controller always owes fiduciary duties to the minority;  (3) narrow the class of cases under which entire fairness is the standard of review by adopting a reinvigorated Sinclair Oil threshold test under which entire fairness is triggered only when the controller receives a benefit at the expense of and to the exclusion of the minority; and (4) improve the regime for cleansing transactions in which entire fairness applies. These changes will reduce costs and encourage beneficial investment, are doctrinally sound, and will enhance Delaware’s position as the state of choice for incorporation.

Delaware Supreme Court Decides TripAdvisor Case: DExit Governed by the Business Judgment Rule Rather Than Entire Fairness: Compared to my Proposed Course Correction

In a significant ruling, the Delaware Supreme Court addressed when a controlling shareholder's actions trigger heightened scrutiny under Delaware corporate law. Maffei v. Palkon, CA No. 2023-0449-JTL (Del. Feb. 4, 2025), available at: https://courts.delaware.gov/Opinions/Download.aspx?id=374990.

Facts

The case involved Gregory Maffei, who controlled both Tripadvisor, Inc. and Liberty TripAdvisor Holdings, Inc. through super-voting shares. Maffei and the boards of both companies sought to change their corporate domiciles from Delaware to Nevada, citing Nevada's more protective liability regime for directors and officers among other reasons.

Though the Conversions received majority approval, this was only achieved through Maffei's controlling votes. The minority shareholders largely opposed the change, with only 5.4% of Tripadvisor's minority shareholders and 30.4% of Liberty TripAdvisor's minority shareholders voting in favor. This stark divide prompted litigation over whether the Conversions should be subject to Delaware's most stringent standard of review - the entire fairness standard.

Ruling

The Delaware Supreme Court reversed the Court of Chancery's application of entire fairness review, holding instead that the more deferential business judgment rule applied. Central to the Court's reasoning was the absence of any concrete, material benefit flowing to Maffei as controller.

While the Court thus reverses the decision below, it does so without harsh criticism or strong language condemning the Vice Chancellor's analysis. The Court primarily disagrees with two aspects of the Vice Chancellor's reasoning. First, it respectfully disagrees with his rejection of a temporal distinction between existing and future potential liability as "arbitrary" and "hard to follow." The Court explains why such temporal distinctions are both workable and consistent with other areas of Delaware law, citing examples from ripeness and standing jurisprudence.

Second, the Court differs with the Vice Chancellor's view that comparing competing corporate governance regimes would be a workable approach to determining whether stockholders received the substantial equivalent of what they had before. The Court suggests that such an analysis would be "unacceptably speculative" and risks intruding on the value judgments of state legislators and corporate directors.

Analysis

According to the Court, the entire fairness standard applies to controller transactions when there is a concrete showing that the controller receives a material, non-ratable benefit from the transaction. Importantly, the Court clarifies that not every benefit that might advantage a controller qualifies as non-ratable.

The Court defines a non-ratable benefit primarily through examples and explanations of what does and does not qualify. The Court explains that classic examples include situations where a director appears on both sides of a transaction or receives a personal benefit not received by shareholders generally. In the controller context, a non-ratable benefit exists when the controller "receives a unique benefit by extracting something uniquely valuable to the controller, even if the controller nominally receives the same consideration as all other stockholders." At its core, a non-ratable benefit thus exists when a controller or fiduciary receives something of value that is not shared equally with other stockholders.

In applying that standard, the Court harmonized and clarified prior precedent by focusing on two key elements: materiality and temporality.

On materiality, the Court explained that a benefit must be sufficiently concrete and substantial. A merely theoretical or speculative advantage is not enough to trigger entire fairness review. The Court agreed with the basic principle that when a controlling stockholder stands on both sides of a transaction or receives something uniquely valuable to the controller, entire fairness applies. However, the benefit must be material enough to create a reasonable inference that it would affect the controller's judgment.

The Court placed particular emphasis on temporality as a key factor in determining materiality. The Court noted that the Conversions occurred on a "clear day"—there was no pending litigation or specific transaction that the change in domicile would affect. In doing so, the Court distinguished between two scenarios. In the first scenario, where controllers take action to extinguish or limit liability for past conduct or existing claims, entire fairness typically applies. The Court cited cases like Bamford v. Penfold and Harris v. Harris, where controllers attempted to eliminate existing potential liability or defeat standing for pending derivative claims. These concrete attempts to escape liability for past actions constituted material, non-ratable benefits triggering entire fairness.

In contrast, in the second scenario, where controllers take action that might affect hypothetical future claims or liability, without any specific threatened or pending litigation, entire fairness generally does not apply. The Court found the potential future benefits of Nevada's more protective liability regime too speculative to constitute a material benefit. This aligns with how Delaware Courts treat other prospective protections, like Section 102(b)(7) charter provisions or D&O insurance, which do not trigger entire fairness merely because they might reduce future liability exposure.

Importantly, the Court noted that if directors or controllers were to take concrete steps toward breaching their duties prior to redomiciliation, even if the breach would not be completed until after the change in domicile, the analysis could be different. But absent such specific conduct or existing claims, the mere possibility of future advantage under a different state's corporate law is insufficient to trigger entire fairness review.

The Court's framework thus requires examining both the nature of the alleged benefit (whether it is concrete and material) and its temporal relationship to the challenged transaction (whether it affects existing or purely prospective liabilities). This approach provides clearer guidance for practitioners while preserving entire fairness review for situations where controllers receive demonstrable, non-ratable benefits at the expense of minority shareholders.

This timing, combined with the speculative nature of any benefits to the controller, led the Court to conclude that the business judgment rule should apply. The ruling reflects Delaware's broader policy of allowing flexibility in corporate governance decisions when there is no concrete showing of self-dealing or receipt of non-ratable benefits by controlling shareholders.

This decision provides important guidance on when redomiciliation decisions will trigger heightened scrutiny, suggesting that theoretical future advantages under a different state's corporate law regime are insufficient without more concrete benefits to the controller.

Comparison to My Approach

In a forthcoming article, A Course Correction for Controlling Shareholder Transactions, available at: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5022685, that Delaware Courts need a course correction. They have pushed the law governing controlling shareholders far beyond legitimate policing into unnecessary and unwise overregulation. This has prompted a backlash in which controllers threaten to reincorporate outside of Delaware, following Elon Musk’s example of moving Tesla to Texas.

Among the course corrections proposed by the article, I argue that the Delaware Courts should narrow the class of cases under which entire fairness is the standard of review by adopting a reinvigorated Sinclair Oil threshold test under which entire fairness is triggered only when the controller receives a benefit at the expense of and to the exclusion of the minority.

While the Court does cite Synthes (which in turn quoted Sinclair Oil) for the proposition that a conflicting interest exists when the controller "derived a personal financial benefit 'to the exclusion of, and detriment to, the minority stockholders,'" it does not establish this as a requirement. Rather, the Court's broader discussion suggests that the key inquiry is whether the controller receives a unique or differential benefit, regardless of whether that benefit actively harms or excludes the minority.

This interpretation is supported by the Court's discussion of cases involving compensation arrangements, consulting agreements, and services agreements between controllers and their controlled entities. In these situations, entire fairness can apply not because the minority is necessarily harmed or excluded from benefits, but because the controller receives something uniquely valuable.

My article and the Court's opinion thus reflect fundamentally different approaches to analyzing when controlling shareholder transactions should trigger entire fairness review, particularly in their treatment of non-ratable benefits.

The most significant divergence appears in how we define when a controller's receipt of non-ratable benefits should trigger heightened scrutiny. As noted, my article advocates for a return to Sinclair Oil's strict two-pronged test, under which entire fairness applies only when a controller receives a benefit that is both to the exclusion of the minority and comes at the minority's expense. In contrast, the Court's opinion focuses primarily on whether the benefit is "material" and "non-ratable," without requiring proof that it directly harms minority shareholders.

The Court and I also differ markedly in our treatment of temporality. While my article does not emphasize timing as a crucial factor in analyzing non-ratable benefits, the Court makes temporality central to its analysis by drawing a sharp distinction between existing or pending claims versus speculative future benefits.

These differences reflect contrasting theoretical frameworks. My article grounds its analysis in the controller's "rights of selfish ownership" and argues that controllers should have broad latitude to receive non-ratable benefits unless they directly harm minorities. The Court, however, focuses more on protecting minority shareholders through robust fiduciary duty analysis, viewing non-ratable benefits with greater inherent suspicion.

These theoretical differences manifest in their practical approaches. My article advocates for a clear threshold test based on Sinclair Oil that would apply business judgment review unless there is both exclusion and detriment. The Court adopts a more nuanced approach focusing on materiality and timing of benefits, allowing for greater judicial flexibility in reviewing controller conduct.

The approaches also diverge in our policy considerations. The article emphasizes market constraints, hypothetical bargains between controllers and minorities, and transaction costs as reasons to limit judicial intervention. The Court focuses more on traditional fiduciary principles and protecting minority shareholders from controller overreach.

In essence, these contrasting approaches reflect a fundamental disagreement about how to balance controller rights against minority protections in corporate law. The article favors clearer rules and greater controller autonomy, while the Court maintains uncertain and unpredictable standards that purport to provide stronger minority protections. This tension demonstrates the ongoing evolution of Delaware law away from the strict Sinclair Oil framework that my article seeks to revive.

More DExit News: Dropbox Reincorporating in Nevada by Written Consent; Another Controlled Company Hits the Road

Apropos the preceding post, a friend flagged for me an announcement from Dropbox that its controlling shareholder approved a reincorporation from Delaware to Nevada. Tellingly, he did so by written consent rather than having a formal shareholder vote.

As I explain in my treatise Corporate Law, 

A majority of states allow shareholders to act without a meeting by unanimous written consent. See, e.g., MBCA § 7.04. A substantial minority, including Delaware, permit shareholders to act by written consent even if the shareholders are not unanimous. See, e.g., DGCL § 228.

DGCL § 228(a) thus provides that:

Unless otherwise provided in the certificate of incorporation, any action required by this chapter to be taken at any annual or special meeting of stockholders of a corporation, or any action which may be taken at any annual or special meeting of such stockholders, may be taken without a meeting, without prior notice and without a vote, if a consent or consents, setting forth the action so taken, shall be signed by the holders of outstanding stock having not less than the minimum number of votes that would be necessary to authorize or take such action at a meeting at which all shares entitled to vote thereon were present and voted and shall be delivered to the corporation in the manner required by this section.

Dropbox's articles of incorporation specifically allow the use of a written consent in lieu of a formal meeting. Typically, you need consent by the holders of a majority of the voting power of the company's stock. Dropbox has two classes of stock: Class A with one vote per share and Class B with 10 votes per share. Dropbox CEO/Chairman of the Board Andrew Houston owns Class A and B shares "representing approximately 77.3% of the voting power of the outstanding shares of capital stock of the Company," so his consent is all that Dropbox needed.

But there is a but. As I further explain in Corporate Law, 

At early common law, it was well-settled that a shareholder acting as a shareholder was entitled to vote his shares without regard to the interests of other shareholders.  As a general matter, it remains the law that shareholders are allowed to act selfishly in deciding how to vote their shares. Conversely, where a shareholder is elected to the board of directors, and acts in his capacity as a director, the shareholder-director naturally assumes fiduciary obligations towards the other shareholders.

Falling between those two extremes is the case of a shareholder with voting control. Absent cumulative voting, such a shareholder’s voting power will suffice to elect the entire board of directors. Recognizing that such a board may not act independently of the controlling shareholder, courts early began to extend the board’s fiduciary duties to the controlling shareholder.  . . .

The canonical parent-subsidiary case remains the Delaware Supreme Court’s opinion in Sinclair Oil v. Levien. . . .

The Delaware Supreme Court identified two standards potentially applicable in [controlling shareholder]  situations: the business judgment rule and the intrinsic fairness rule. Under the business judgment rule, the controlling shareholder gets the benefit of a rebuttable presumption of good faith. Under the intrinsic fairness test, the burden of proof is on the controller to show, subject to close scrutiny, that the transactions were objectively fair to Sinven. . . .

By virtue of controlling more than a majority of Dropbox's stock, Mr. Houston is per se a controlling shareholder. As such, he owes fiduciary duties to the minority shareholders of Dropbox. Which brings me to Vice Chancellor Travis Laster's decision in the TripAdvisor case, Palkon v. Maffei, 311 A.3d 255 (Del. Ch. 2024), which held that:

Delaware's most onerous standard is entire fairness. Under that standard, the fiduciary defendants must establish “to the court's satisfaction that the transaction was the product of both fair dealing and fair price.” ...

Delaware law has deemed the business judgment rule rebutted and applied the entire fairness test ab initio to any transaction between the corporation and a controlling stockholder in which the controller receives a non-ratable benefit. ...

Under Delaware law, a controller or other fiduciary obtains a non-ratable benefit when a transaction materially reduces or eliminates the fiduciary's risk of liability. ...

The real question for determining the standard of review is whether a decision confers a material benefit on the fiduciaries who made it. Here, it is reasonable to infer at the pleading stage that the conversions will confer a material benefit on the fiduciary defendants who approved them. ...

At the pleading stage, it is reasonable to infer from the complaint's allegations that Nevada law provides greater protection to fiduciaries and confers a material benefit on the defendants. ...

The complaint's allegations about the laxity of Nevada law are well taken. Michal Barzuza has demonstrated that:

Nevada [ia] an almost liability-free jurisdiction. Without much public attention, Nevada has embarked on a strategy of market segmentation with a differentiated product — a shockingly lax corporate law. Nevada law generally protects directors and officers from liability for breaches of the duties of loyalty, good faith, and care that are widely believed to be staples of U.S. corporate law. Nevada highlights these broad protections as a reason to incorporate there rather than in Delaware

Nevada's more lax approach to fiduciary duties will redound to the benefit of Dropbox's controller, as well as its other directors and managers. Hence, if challenged, the reincorporation decision will be subject to review under the entire fairness doctrine.

This will be true even if Dropbox proceeds expeditiously with the reincorporation. In the TripAdvisor case, VC Laster opined that:

The defendants finally argue that even if the plaintiffs have stated a claim on which relief can be granted, they cannot obtain an injunction blocking the Company and Holdings from leaving Delaware. They seem to think that as a matter of policy, a Delaware court cannot enjoin an entity from leaving the state. That assertion goes too far. In extreme scenarios, courts have the power to prevent persons and assets from leaving their jurisdiction when doing so is necessary to preserve their ability to award final relief. In theory, therefore, this court could enjoin the Company or Holdings from departing Delaware if the equities warranted it. But the circumstances in which the equities might warrant that extreme result are limited. They are not present here. …

Because of the narrow issue that this case presents, it seems likely that the court will have a sufficiently reliable basis to craft a monetary award for any harm that the Company's stockholders suffer. A judgment against the defendants in that amount should provide the plaintiff with a fully adequate remedy. The court will retain jurisdiction over the individual defendants even after the conversion is complete. The court can enter a judgment against any of them who are held liable. The plaintiffs can use standard collection procedures to enforce the judgment. If that requires domesticating judgments in other jurisdictions and enforcing them there, then the plaintiffs can do that.

The closing of the conversion will not alter anything else about the case. By statute,

[t]he conversion of a corporation out of the State of Delaware in accordance with this section and the resulting cessation of its existence as a corporation of this State pursuant to a certificate of conversion to non-Delaware entity shall not be deemed to affect ... the personal liability of any person incurred prior to such conversion, nor shall it be deemed to affect the choice of law applicable to the corporation with respect to matters arising prior to such conversion.

Any liability for the conversion necessarily arises prior to the mystical singularity of the effective time. This case will go forward, governed by Delaware law, regardless of whether the Company's conversion closes.

Assuming litigation occurs, the default rule is that the defendant fiduciaries have the burden of proving that the transaction was fair to Dropbox and the minority shareholders. But Houston and his fellow officers and directors may have at least partially cleansed the transaction:

Back to my Corporate Law, 

In Kahn v. Lynch Communication Systems,  the Delaware Supreme Court held that approval of a freeze-out transaction or any other conflicted controller transaction “by an independent committee of directors or an informed majority of minority shareholders shifts the burden of proof on the issue of fairness from the controlling or dominating shareholder to the challenging shareholder-plaintiff. Nevertheless, even when an interested cash-out merger transaction receives the informed approval of a majority of minority stockholders or an independent committee of disinterested directors, the entire fairness analysis is the only proper standard of judicial review.” It is simply that the plaintiff now has the burden of proving that the transaction was unfair. 

. . .

In Kahn v. M & F Worldwide Corp.,  the Delaware Supreme Court expanded the protections potentially available to controlling shareholders. It held that a freeze-out merger would be reviewed under the business judgment rule rather than the fairness standard if six conditions are met: (1) the controlling stockholder conditions the transaction on the approval of both a special committee and the majority of the minority stockholders, (2) the special committee is independent, (3) the special committee is empowered to select its own advisors and to say no definitively, (4) the special committee meets its duty of care in negotiating a fair price, (5) the vote of the minority stockholders is informed, and (6) there is no coercion of the minority stockholders. . . .

Note that a controlling shareholder is not required to comply with MFW; like any safe harbor, it is purely optional. If the controlling shareholder wishes, it could comply with the older Lynch approach and shift the burden of proving lack of entire fairness to plaintiff by relying on an independent director vote standing alone. Indeed, a controlling shareholder who wishes to do so, could seek neither approval by a special committee of independent directors or the majority of the minority shareholders, in which case the defendant controller would retain the burden of proving the deal’s entire fairness.

It appears that Houston has gone with the middle option, planning to invoke Lynch rather than MFW. Dropbox's announcement informs us that:

The members of the evaluation committee were Lisa Campbell, who served as chairperson, Paul Jacobs and Karen Peacock. In addition, Don Blair, the Company’s lead independent director, was named an ex officio member of the evaluation committee. The board of directors believed these directors were appropriate to comprise the evaluation committee because Ms. Campbell and Dr. Jacobs constitute the Company’s Nominating and Corporate Governance Committee, which is responsible for reviewing and recommending to the board of directors any changes to the Company’s corporate governance framework (including to its certificate of incorporation and bylaws); Ms. Peacock has significant experience in executive-level operational roles, including in organizations navigating business transformations similar to that confronting the Company; and Mr. Blair is the Company’s lead independent director.

According to Dropbox's latest proxy statement, the board has determined that all members of the evaluation are independent under the NASDAQ listing standard definition of independence. If so, and they made an informed decision, the burden of proof should shift to plaintiff to prove that the decision was unfair.

The potential glitch, however, is that Delaware does not use the stock exchange listing standard definitions of independence. Instead, as I discuss in my recent article, A Course Correction for Controlling Shareholder Transactions, the Delaware courts have heightened the rigor with which cleansing standards are applied, particularly regarding the criteria for independent directors. 

In any case, Dropbox's announcement is another piece of anecdotal evidence that my other recent article,  DExit Drivers: Is Delaware's Dominance Threatened?, which is forthcoming in the Journal of Corporation Law, correctly argues that most major companies leaving Delaware will be companies with controlling shareholders.

DEXIT News: Will Meta Follow Tesla to Texas?

The WSJ reports:

Meta Platforms is discussing moving its incorporation from Delaware, where most big U.S. companies are legally housed, people familiar with the matter said. Texas has billed itself as a better destination for companies such as Meta with controlling shareholders like Zuckerberg. ...

Executives and controlling shareholders of public companies have long expressed frustration with the Delaware Court of Chancery, which has become home to a thriving shareholder plaintiffs’ bar. The big companies that have reincorporated elsewhere have tended to have a dominant owner potentially affected by recent Delaware decisions. ...

“The Texas state government is trying to send out signals that the Texas state courts will be more friendly to businesses than the Delaware court has been,” said Stephen Bainbridge, a law professor at the University of California, Los Angeles. “But there’s no guarantee that that’s going to happen.”

Regular readers will recall that my two most recent law review articles speak to this precise issue. DExit Drivers: Is Delaware's Dominance Threatened?, which is forthcoming in the Journal of Corporation Law, provides empirical data on reincorporations out of Delaware. It concluded that the number of reincorporations from Delaware remains trivial compared to the vast number of new incorporations Delaware attracts annually. Given the strong inertia behind the initial incorporation decision and the weak drivers for DExit, it seems unlikely to become widespread soon. 

But there is a but. My article opines that:

None of the companies in our dataset identified controlling shareholder liability exposure as a motivation for reincorporating, but there is reason to suspect that it was an important motivator for a subset of the redomiciling corporations in our study. ...

Delaware courts have decided a series of recent high profile cases that have raised controller’s liability exposure.  Specifically, in cases “involving Tesla Inc., TripAdvisor Inc., Moelis & Co., and Sears Hometown and Outlet Stores Inc.,” the court has “sought to tighten the standards for conduct by controlling stockholders.”  Areas in which the Chancery Court is perceived to have tightened standards respecting controllers include a broader definition of who is in control, expanding the class of conflicted transactions requiring cleansing, and the strictness with which the standards for cleansing are applied, especially with respect the definition of who is an independent director. . . .

As such, concerns about both the application of the law and the tone of the opinions are mounting. A New York-based corporate law partner observed that uncertainty about the definition of independence is a major concern among those voicing skepticism about the direction of Delaware law.  The same partner noted a growing impression that certain Delaware Chancery Court judges have developed a skeptical attitude towards independence of directors of Silicon Valley firms.  Similar sentiments were expressed by both a prominent Delaware academic and a leading Delaware practitioner.  On her group blog, Professor Ann Lipton likewise speculated that these developments may “hit Silicon Valley companies particularly hard, because of the chumminess of the tech world, and it's not surprising that once independence is questioned, the tone of the opinions is going to come off as skeptical, in a manner that defendants do not like.”

Having said that, however, neither Texas nor Nevada (Delaware's other major competitor has a well developed body of law governing the fiduciary duties of controlling shareholders.

In addition, it is possible that Delaware courts will adopt a course correction that rebalances the law governing controllers. Indeed, my other recent article, A Course Correction for Controlling Shareholder Transactions, advocates just such a correction. Or, more precisely, four corrections:

...  the courts: (1) should narrow the definition of controller; (2) should not attempt to sort out in which cases controllers owe fiduciary duties to the minority from those in which they do not, but instead hold that a controller always owes fiduciary duties to the minority;  (3) narrow the class of cases under which entire fairness is the standard of review by adopting a reinvigorated Sinclair Oil threshold test under which entire fairness is triggered only when the controller receives a benefit at the expense of and to the exclusion of the minority; and (4) improve the regime for cleansing transactions in which entire fairness applies. These changes will reduce costs and encourage beneficial investment, are doctrinally sound, and will enhance Delaware’s position as the state of choice for incorporation.

The article argues that these corrections are necessary because:

Delaware courts increasingly exhibit a reflexive suspicion of transactions involving a controlling shareholder.  The court has operationalized that skepticism by notably broadening the definition of who qualifies as a controlling shareholder. In particular, the courts are increasingly willing to hold that shareholders who own less than a majority of the corporation’s voting power nevertheless possess control.  Taken to its logical extreme, this trend easily could result in someone being deemed a controller even in the absence of stock ownership.  

The court’s growing skepticism of controlling shareholders is further reflected in its tightening of the standards governing the conduct of controlling shareholders.   In doing so, the court has expanded the range of conflicted transactions necessitating cleansing and heightened the rigor with which cleansing standards are applied, particularly regarding the criteria for independent directors. 

This article contends that Delaware courts need a course correction. They have pushed the law governing controlling shareholders far beyond legitimate policing into unnecessary and unwise overregulation. This has prompted a backlash in which controllers threaten to reincorporate outside of Delaware, following Elon Musk’s example of moving Tesla to Texas. 

I confess to taking a certain amount of pleasure in saying I told you so.

By the way, as I have said before, the UCLA Law Library is one of UCLAW's crown jewels. The reference staff is exceptionally friendly, helpful, knowledgeable, and supportive. The DExit article would not have been possible without their support. Likewise, this blog post owes our head librarian a shout out, as he flagged the WSJ article for me. It's precisely the sort of little assists they do routinely that make this such a supportive environment. Prospective students and faculty should take our library's excellence into account when deciding whether to join us.

Agency, Partnerships, and Limited Liability Entities: Cases and Materials on Unincorporated Business Associations--6th Edition

Foundation Press has announced that the 6th edition of Agency, Partnerships, and Limited Liability Entities: Cases and Materials on Unincorporated Business Associations is now available for pre-orders.

This book is a collection of edited cases, original text, questions, and problems designed for use in a law school level course on agency, partnerships, and limited liability entities. A key feature of this casebook is the extensive coverage of limited liability entities, especially unincorporated limited liability companies (LLCs). The authors include cases on such LLC topics as formation, interpretation of the operating agreement, piercing the LLC "veil," fiduciary obligation, expulsion of an LLC member, and dissolution. Also included is a section on the question of whether membership interests in LLCs and limited partnerships are a security. This edition has been meticulously updated with important new cases and rules.

In this edition, I am joined by two new coauthors: James Park (UCLA) and Usha Rodrigues (Georgia). I was delighted that these two outstanding corporate law scholars wanted to work with me and our partnership went very well. I think the new book is even better than ever thanks to their contributions.

 

Does Trump's Anti-DEI order conflict with Dodd-Frank?

President Trump promulgated an executive order providing in pertinent part that:

I therefore order all executive departments and agencies (agencies) to terminate all discriminatory and illegal preferences, mandates, policies, programs, activities, guidance, regulations, enforcement actions, consent orders, and requirements.  I further order all agencies to enforce our longstanding civil-rights laws and to combat illegal private-sector DEI preferences, mandates, policies, programs, and activities.

Agencies is not a defined term in the order but the accompanying fact sheet claims that the order "terminates 'diversity, equity, and inclusion' (DEI) discrimination in the federal workforce, and in federal contracting and spending.

The Dodd-Frank Act of 2010 created 12 USC § 5452, which provides in subsection (a)(1)(A) that:

Except as provided in subparagraph (B), not later than 6 months after July 21, 2010, each agency shall establish an Office of Minority and Women Inclusion that shall be responsible for all matters of the agency relating to diversity in management, employment, and business activities.

Subparagraph (B) refers to a comparable requirement applicable to the Bureau of Consumer Financial Protection. 

12 USC § 5452(g)(1) defines the term agency for this purpose to include "A) the Departmental Offices of the Department of the Treasury; (B) the Corporation; (C) the Federal Housing Finance Agency; (D) each of the Federal reserve banks; (E) the Board; (F) the National Credit Union Administration; (G) the Office of the Comptroller of the Currency; (H) the Commission; and (I) the Bureau."

Section 5452 lays out extensive requirements for the mandated Offices, including specified steps the agencies must take to "seek diversity in the workforce," providing annual reports to Congress on matters such as "the successes achieved and challenges faced by the agency in operating minority and women outreach programs," and the like.

The conflict with Trump's order seems obvious.

But Trump's DEI order includes a provision that "Nothing in this order shall be construed to impair or otherwise affect: (i) the authority granted by law to an executive department, agency, or the head thereof ...." It seems that this saving provision would preserve the OMWIs at the Dodd-Frank regulated financial agencies.

Interestingly, as of January 24th, the SEC has scrubbed its DEI page but its OMWI page remains up.