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.
