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.