A recent post criticized the Restatement of the Law of Corporate Governance's approach to the law of controlling shareholders. The Reporters have sent along this response:
In your blog post, you take issue with two elements of Section 5.10, which was approved by the ALI at its May 2022 annual meeting.
The first element relates to the types of transaction in which a controller is considered to be interested. Your blog post suggests that the restatement is taking an approach that is “entirely different” from the Delaware Supreme Court’s approach in Sinclair Oil. v. Levien, 280 A.2d (Del. 1971). Yet, the restatement is completely consistent with Sinclair Oil. Under section 1.23, which defines “interested” and is referenced in section 5.10, a controller is interested if the controller “receives a benefit … when the benefit … is not shared with shareholders pro rata …”. The issue in Sinclair Oil was whether a parent was conflicted as to a dividend paid by its non-wholly owned subsidiary. The dividend was paid pro rata to the parent and the subsidiary’s minority shareholders. The Delaware Supreme Court held that there was no conflict—a sound decision and one with which the restatement fully accords, both in its black letter and in comment 3. Sinclair Oil also deals with another issue: whether the parent usurped a corporate opportunity belonging to the subsidiary. But corporate opportunities involving controllers are addressed neither by section 5.10 nor by section 1.23 (they will be addressed by a different provision yet to be drafted) and these sections can thus hardly take a different approach to that issue than did Sinclair Oil.
The second, and more important, element you take issue with relates to the standard of review that applies when a controller is interested in a transaction involving a controlled entity. Absent a cleansing act, there is broad consensus that a fairness standard applies. But what if there was a cleansing act? Under Kahn v. Lynch, a 1994 decision by the Delaware Supreme Court that has been followed by other jurisdictions that have addressed that issue, a single proper cleansing act has the effect of shifting the burden of proof on fairness, rather than of reinstating the business judgment rule. And under MFW, a 2014 decision by the Delaware Supreme Court that has been followed by New York but has been rejected by Oklahoma, two proper cleansing acts have the effect of reinstating the business judgement rule.
Both Lynch and MFW involved freeze-out mergers. But Kahn v. Tremont, 694 A.2d 422 (Del. 1997) involved a regular self-dealing transaction between a Valhi (an entity owned Simmons) and Tremont (an entity controlled by Simmons). In Tremont, the Delaware Supreme Court noted:
Ordinarily, in a challenged transaction involving self‑dealing by a controlling shareholder the substantive legal standard is that of entire fairness, with the burden of persuasion resting upon the defendants. Weinberger v. UOP, Inc., Del. Supr., 457 A.2d 701, 710 (1983). The burden, however, may be shifted from the defendants to the plaintiff through the use of a well-functioning committee of independent directors. Kahn v. Lynch Communication Sys., Del. Supr., 638 A.2d 1110, 1117 (1994).
Id. at 428.
Subsequent to Tremont, a plethora of Chancery court cases have applied the Lynch framework in settings other than freeze-out mergers. The notes to section 5.10 list over 10 such opinions by the Chancery court, of which about half are reported.
To be sure, the blog is correct in noting that several of these opinions pre-date MFW. But the relevance of this point escapes me. MFW does not speak to the issue of which transactions are subject to Lynch to start with. Moreover, I do not think that there is anyone who has argued that, under Delaware law, a transaction that is subject to the Lynch rule, meaning that a single cleansing merely shifts the burden under a fairness test, is not also subject to the MFW gloss on Lynch, meaning that two proper cleansing acts reinstate the business judgment rule. The relevant date for whether a Delaware court decision elucidates the scope of Lynch is thus the date when the Lynch rule was announced, not the date when it was clarified by MFW. And all the cited cases post-date Lynch.
Several leading commentators, including two highly respected former Delaware judges, have criticized these Chancery court decisions. There are certainly cogent arguments for limiting the scope of transactions subject to the Lynch rule, as there are cogent arguments in the other direction. But when the weight of judicial authority is overwhelmingly in one direction—and for these purposes, law review articles by former members of the judiciary do not constitute judicial authority—the role of the restatement is not to evaluate these policy arguments, or to predict rulings by the Delaware Supreme Court in a yet-to-be-filed case, but to restate the law as it stands today. And that is what Section 5.10 has done.
