In the preceding post, I commended to your attention Professor Ann Lipton's thoughtful post on VC Laster's recent decision in United Food & Commercial Workers Union v. Zuckerberg. (As she kindly notes, I also blogged about that case recently.)
After the extended and useful discussion of how the case exemplifies some of the key "pathologies associated with the common law," Ann turns to the merits of the case:
... when it comes to the underlying substantive dispute in Zuckerberg, I’m not sure I agree with Laster’s analysis.
The lawsuit arose out of Mark Zuckerberg’s ill-fated proposal to amend Facebook’s charter to create a class of no-vote shares, essentially to allow him to transfer much of his financial interest in the company while maintaining his hold on the high-vote B shares that give him control. As many will recall, the Board recommended the charter amendment and the shareholders – dominated by Zuckerberg’s high vote shares – voted in favor, but in a subsequent lawsuit, stockholder-plaintiffs uncovered multiple irregularities that had occurred in the course of negotiating the proposal. Zuckerberg dropped the plan, and that was that, until new plaintiffs brought a derivative lawsuit alleging that even though the plan was abandoned, all of the expenditures associated with it damaged the company. Thus, the question before Laster was whether the Facebook Board was sufficiently disinterested and independent to decide whether to bring a lawsuit over the Board’s earlier approval of the charter amendments, namely, whether to sue many of its own members. And that question turned, in part, on whether Reed Hastings and Peter Thiel, two of Facebook’s Board members, faced a substantial risk of liability for having voted in favor of the charter amendment in the first place.
So really, part of the underlying legal question here was whether Hastings and Thiel breached their duties of loyalty by recommending the charter amendment. The plaintiffs argued, in part, that they did so because they were “biased” in favor of founder control – namely, they believed that corporate founders should be able to run their companies free from the meddling influence of public shareholders.
Laster held that even if this was their reasoning, it did not constitute a lack of loyalty:
A director could believe in good faith that it is generally optimal for companies to be controlled by their founders and that this governance structure is value-maximizing for the corporation and its stockholders over the long-term. Others might differ. As long as an otherwise independent and disinterested director has a rational basis for her belief, that director is entitled (indeed obligated) to make decisions in good faith based on what she subjectively believes will maximize the long-term value of the corporation for the ultimate benefit of its residual claimants. If a director believes that it will be better for the corporation to have the founder remain in control, then the director may make decisions to achieve that goal. As long as a director acts in good faith, exercises due care, and does not otherwise have any compromising interests, a director will not face liability for making a decision that she believes will maximize the long-term value of the corporation for the ultimate benefit of its residual claimants,…
The belief that founder control benefits corporations and their stockholders over the long run is debatable, but it is not irrational.
To which I respond – what about Blasius?
In Blasius Industries v. Atlas, an incumbent board maneuvered to neuter the effects of shareholder consents that would otherwise have replaced it with a dissident slate. Chancellor Allen held that even if the Board sincerely and in good faith believed the dissident slate would harm the company and its own plans were better for shareholders, the incumbents would violate their fiduciary duties by taking the choice out of the shareholders’ hands.
To which I respond, well, what about Blasius? I have huge respect for Chancellor Allen. But even mighty Homer nodded. Allen's record has more than a few glitches. Caremark was wrong when decided and gave birth to an increasingly awful body of law. Credit Lyonnais was a disaster waiting to happen, although the Delaware Supreme Court managed to nip that one in the bud. And Blasius may be the worst of the bunch.
By the way, I discuss Blasius in my new Advanced Corporation Law text (and it as much a text as it is a casebook, so practicing lawyers will want a copy too).
Ever since Allen invented Blasius, the Delaware courts have struggled to figure out what to do with it.As Former Delaware Chief Justice Leo Strine aptly observed in an opinion written while he was still on the Chancery Court, Blasius is not "a genuine standard of review that is useful for the determination of cases," but rather "an after-the-fact label placed on a result." Mercier v. Inter-Tel (Delaware), Inc., 929 A.2d 786, 788 (Del. Ch. 2007).
Indeed, as Strine also observed, post-Blasius cases are commonly “threshold exertions in reasoning as to why director action influencing the ability of stockholders to act did not amount to disenfranchisement, thus obviating the need to apply Blasius at all.” Id. at 806. Personally, I think they're embarrassed by it and the failure to overturn it is one of those pathologies about which Professor Lipton was writing.
One of the first things the Delaware courts did to limit Blasius was to effectively subsume Blasius into the Unocal standard "where the board 'adopts any defensive measure taken in response to some threat to corporate policy and effectiveness which touches upon issues of control.'” Stroud v. Grace, 606 A.2d 75, 92 n.3 (Del. 1992)
Shortly thereafter they limited Blasius to cases of unilateral board action. See, e.g., Williams v. Geier, 671 A.2d 1368, 1376 (Del. 1996) ("Blasius is appropriate only where the primary purpose of the board's action [is] to interfere with or impede exercise of the shareholder franchise, and the stockholders are not given a full and fair opportunity to vote"; internal quotation marks deleted).
Strine built on that foundation when he was a Vice Chancellor Portnoy v. Cryo-Cell Int’l, Inc.,940 A.2d 43 (Del. Ch. 2008). He declined to apply Blasius to vote buying. To be sure, Strine’s opinion in Portnoy can be seen as part of a larger trend in Delaware corporate law towards judicial deference to informed, non-coerced shareholder votes. But if Blasius doesn't reach vote buying, what's left of it?
In another case, Strne declined to apply Blasius where the board of directors timed a shareholder vote to be held before a dual class capital structure expired even though the board knew that after that structure expired a favorable vote would be much harder to obtain. In re Gaylord Container Corp. S'holders Litig., 753 A.2d 462, 469, 486-87 (Del. Ch. 2000) (Strine, VC).
In light of such decisions, a New York court has suggested that Blasius is now limited to proxy contests involving director elections:
Blasius a... application has been largely limited to disputes over the election of directors. Accordingly, “courts will apply the exacting Blasius standard sparingly, and only in circumstances in which self-interested or faithless fiduciaries act to deprive stockholders of a full and fair opportunity to participate in the matter.” Of particular significance here, “the reasoning of Blasius is far less powerful when the matter up for consideration has little or no bearing on whether the directors will continue in office."
In re Bear Stearns Litig., 870 N.Y.S.2d 709, 733 (N.Y. Sup. 2008) (citations and footnote omitted).
So what about Blasius? "Blasius is simply an unworkable standard of review, as once a court triggers Blasius, it would seem impossible for the directors to provide a compelling justification for disenfranchising their shareholders.” Mary Siegel, The Problems and Promise of "Enhanced Business Judgment", 17 U. Pa. J. Bus. L. 47, 81 (2014).
It is also an unnecessary standard. In Schnell v. Chris-Craft Indus., Inc., 285 A.2d 437, 439 (Del.1971), the Delaware Supreme Court held that “inequitable action does not become permissible simply because it is legally possible."
The Schnell decision has been routinely used to strike down board of director action that improperly infringed on shareholder voting. Consider, for example, the unjustly overlooked case of Alpha Sunde Smaby and her almost successful campaign to be elected to the board of Northern States Power Company. The company used cumulative voting to elect directors. Smaby was put forward with support from environmental and consumer groups. Under the prevailing articles and bylaws, Smaby needed about 7% of the votes to be elected. She was thought likely to get the votes of about 9%. The board amended the bylaws to reduce the number of directors from 14 to 12 and to adopt a classified board. Under the new bylaws, with three classes of four directors each and only one class up for election in the current year, Smaby needed 20% of the votes to win. In reliance on Schnell, the court struck down the bylaw changes:
In the instant case, the actions of the insiders, if not unfair, were certainly questionable in light of their fiduciary obligation to the plaintiff shareholders. Not only did the defendants change the rules in the middle of the game, but they refused to disclose the existence of the changes when approached by the plaintiffs. Both of these actions served to frustrate the plaintiff shareholders’ legitimate efforts to run for the Board of Directors and may well be a breach of fiduciary duty. ...
Coalition to Advocate Public Utility Responsibility, Inc. v. Engels, 364 F. Supp. 1202 (D. Minn. 1973). (It's in my Advanced Corporation Law book.) What more do you need?
Finally, and I will not expound on this point at any length, Blasius is fundamentally flawed because it rests on a deeply erroneous premise. It rests on Allen's belief that corporate law assumes corporate democracy. Disproving that claim, of course, has been my principal contribution to corporate law and my principal claim to fame. For a concise treatment, I refer you to my book The New Corporate Governance in Theory and Practice
