ProfessorBainbridge.com: Corporate Law

Fox Corp., Officer Exculpation, and Delaware Law

Delaware recently amended its General Corporation Law to permit corporations to adopt provisions in their articles of incorporation allowing exculpation of their officers (in addition to the longstanding permission to have exculpation clauses applicable to directors):

The officer liability exculpation provision is not self-effectuating; instead, the amendment to Delaware law allows companies to take action to adopt exculpation provisions that protect covered officers from personal liability on the same basis as directors—that is, for all fiduciary duty claims other than breaches of the duty of loyalty, intentional misconduct or knowing violations of law—with an additional exception that claims against officers will not be barred “in any action by or in the right of the corporation.”

Under the newly amended provision of Delaware law, covered officers eligible for such exculpation from liability, if implemented by the corporation, will include the president, chief executive officer, chief operating officer, chief financial officer, chief legal officer, controller, treasurer or chief accounting officer, the company’s most highly compensated executive officers as identified in SEC filings and certain other officers who have consented (or deemed to have consented) to be identified as an officer and to service of process. Companies and boards themselves will retain the right to bring appropriate actions against officers, and this additional exception will permit stockholder derivative claims against officers for breach of the duty of care to continue to be brought if demand requirements are met.

Bloomberg reported today that:

A Nov. 4 lawsuit against Fox Corp. over its adoption of the protection highlights the question of how some shareholders might respond. ...

“Due care claims targeting officers are the latest result of the shareholder plaintiffs’ bar’s efforts to develop litigation tactics that offer potentially lucrative fee awards” in mergers and acquisitions lawsuits, according to a research paper, written last year by two former Delaware Supreme Court justices and a University of Pennsylvania law professor. ...

Fox was sued by the Electrical Workers Pension Fund, Local 103, I.B.E.W. in what may be the first lawsuit related to the new liability shield. The pension fund’s legal challenge stems from Fox’s dual-class voting structure, which generally gives no voting rights to holders of Class A common stock.

The pension fund argues that, as a Class A shareholder, it has the right under Delaware law to vote on the change.There’s early momentum behind adoption of the provision.

Keith Paul Bishop explains in more detail:

The complaint does not challenge the statutory amendment. Rather, it challenges the procedure by which Fox Corporation adopted the amendment. According to the complaint, Fox Corporation has a dual class share structure and the amendment was approved by the voting shares but not the non-voting shares. The plaintiff hinges its case on Section 242(b)(2) of the Delaware General Corporation Law which provides that holders of a class of stock are “entitled to vote as a class upon a proposed amendment, whether or not entitled to vote thereon by the certificate of incorporation, if the amendment would . . . alter or change the powers, preferences, or special rights of the shares of such class so as to affect them adversely.” According to the plaintiff, the right to seek judicial relief to hold officers accountable for reckless or grossly negligent behavior is a component of the “bundle of rights” appurtenant to the non-voting stock. Therefore, the amendment required the affirmative vote of the non-voting stock. It remains to be seen how the Court of Chancery will deal with this novel theory.

California does not presently permit the articles of incorporation to include a provision exculpating officers. If it did, I don't think that the plaintiff's argument would succeed in the case of a California corporation.

In an earlier post, Bishop questioned the legal basis under which Delaware purports to authorize the exculpation of officers. He pointed out that the relationship between the officers and the corporation is subject to the law of agency and the choice of laws principals pertaining thereto. For example, an officer might have an employment agreement governed by the law of a state other than Delaware. Even without an express choice of law provision, the employment arrangement may be governed by the substantive law of another state.

Yet, if Bishop is correct, doesn't that suggest that the longstanding rules on indemnifying officers set out in DGCL section 145 would be invalid? After all, agency law also governs indemnification of employees. Likewise, Bishop's argument seems to call into question the validity of DGCL section 144's regulation of interested director and officer transactions. Again, agency law governs employee duty of loyalty issues.

Larry Hammermesh commented in an email exchange:

First, there are lots of ways in which Delaware law defines the corporate/officer relationship: it prescribes a great deal about indemnification (including mandatory indemnification), and if Delaware law didn't govern the relationship at least to some extent, stockholder claims against officers would have to be dismissed outright because officers owe no duty, fiduciary or otherwise, to stockholders directly under agency or contract law.

Second, even if the charter as "contract" isn't one to which officers are a party, there's no question that the Delaware statute can define and limit the rights of stockholders, including all aspects of their right to sue. ... As long as Delaware statute can define and limit the rights of stockholders of a Delaware corporation, it can define and limit their right to sue for a breach of some duty (of an officer, director, or controlling stockholder) that arises under Delaware corporate law.

Posted at 05:08 PM in Corporate Law | Permalink | Comments (0)

Are Directors Employees? Are they Agents?

As far as corporate and agency law are concerned, directors of a corporation qua directors are neither employees nor agents of the corporation on whose board they serve.

A search of the law pertaining to the relationship between a corporation and its directors reveals that the corporate directors are not agents of the corporation since they are the controllers rather than the controlled, but neither are they the master of the corporation's employees. Their position makes them sui generis in the hierarchy of legal conceptions. W. Seavey, Agency s 10(B) (1964).

Miller and Rhoads v. West, 442 F. Supp. 341, 344 (E.D. Va. 1977).

Section 14C of the Restatement (Second) of Agency takes the position that "[n]either the board of directors nor an individual director of a business is, as such, an agent of the corporation or of its members." The drafters explained:

An individual director, as such, has still less resemblance to an agent than has the board as a body. He has no power of his own to act on the corporation's behalf, but only as one of the body of directors acting as a board. Even when he acts as a member of the board, he does not act as an agent, but as one of the group which supervises the activities of the corporation.

Despite all this there are some other bodies of law that may treat directors as employees for certain limited purposes. Keith Paul Bishop offers ups list of his posts in which he has addressed some examples:

Posted at 01:02 PM in Corporate Law | Permalink | Comments (0)

Tweeting with Ann Lipton re Extending Caremark into Unregulated Spaces

Sigh. As I feared, Caremark keeps growing. Even though I argued "Don’t Compound the Caremark Mistake by Extending it to ESG Oversight," I fear that may well happen. https://t.co/E8GEjMKwUK
— Steve Bainbridge (@PrawfBainbridge) November 8, 2022

They actually kind of objected to ESG Caremark though, even as they said the other stuff.
— Ann "Parody Account" Lipton (@AnnMLipton) November 8, 2022

Posted at 12:58 PM in Corporate Law | Permalink | Comments (0)

Tweeting with Ann Lipton re What Happens if there is Unfair Dealing but a Fair Price

Perhaps you tagged me in because you recall my post "Calculating Damages Where the Breach of Fiduciary Duty Involves a Flawed Process: What Happens if There is Unfair Dealing but the Price is Fair"? https://t.co/dZwGtw75dS #lawtwitter
— Steve Bainbridge (@PrawfBainbridge) November 8, 2022

Posted at 12:55 PM in Corporate Law | Permalink | Comments (0)

Fiduciary Duties in Delaware Corporate Law Do Not Assume Investor Diversification

The Chancery Daily recently noted shareholder activist's James McRitchie lawsuit against Meta (f.k.a. Facebook):

Meta is the largest social media network company in the world, with 3.5 billion users -- 43% of humanity. Its business decisions inevitably create financial impact well beyond its own cash flows and enterprise value and have significant impacts on the global economy. While defendants have a duty to operate the Company as a business for the financial benefit of its stockholders, those stockholders are often diversified investors with portfolio interests beyond Meta's own financial success. If the decisions that maximize the Company's long-term cash flows also imperil the rule of law or public health, the portfolios of its diversified stockholders are likely to be financially harmed by those decisions. As fiduciaries at a corporation with a business model that depends upon maintenance of a powerful global network, the directors and officers of the Company cannot willfully blind themselves to this reality: where there is great power there is great responsibility.

For a corporation whose impact is so widespread, the well-established doctrine of stockholder primacy cannot be rationally applied on behalf of investors without recognizing the impact of portfolio theory, which inextricably links common stock ownership to broad portfolio diversification. The economic benefits from -- indeed the viability of -- a system of corporate law rooted in maximizing financial value for stockholders would vanish if it forced directors to make decisions that increased corporate value but depressed portfolio values for most of its stockholders. But this is precisely how the Company has operated: Defendants have ignored the interests of all of its diversified stockholders, making decisions as if the costs that Meta imposes on such portfolios were not meaningful to stockholders.

This is hardly a new argument. back in the heyday of hostile takeovers, Easterbrook and Fischel argued that:

If the portfolios are sufficiently diversified, these investors will be on both sides of tender offer auctions, holding positions in bidding corporations and target corporations alike. They cannot gain from the higher premium paid to the targets' shareholders because they lose as investors in bidders what they gain as investors in targets. And they lose more to boot. First, the costs of running the auctions are a dead weight loss to them and to society. Second, they lose because the increased costs of bidding lead to fewer offers and thus, as a result of decreased monitoring and higher agency costs, to lower prices for all firms that are neither targets nor bidders.

Investors holding diversified portfolios therefore would not ‘balance’ the size of premia against the frequency of offers. They view premia as transfers from one of their pockets to another, and they care solely about the effects of auctions on monitoring.

Frank H. Easterbrook, Auctions and Sunk Costs in Tender Offers, 35 Stan. L. Rev. 1, 8 (1982). Despite the fact that diversified investors would prefer to maximize the number of takeovers rather than the premium paid in any specific deal, Delaware law makes clear that in Revlon-land directors of a target company have a duty to maximize the size of the premium. They may not consider the global effect of their efforts to do so. See Bernard Black & Reiner Kraakman, Delaware's Takeover Law: The Uncertain Search for Hidden Value, 96 Nw. U. L. Rev. 521, 533 (2002) (observing that Delaware case law prioritizes “the interests of undiversified investors [over] those of diversified investors”); Franklin Gevurtz, Removing Revlon, 70 Wash. & Lee L. Rev. 1485, 1551 (2013) (“Accepting this sort of portfolio based approach to determining shareholder interest would radically rewrite corporate law in ways reaching far beyond Revlon.”).

More generally, Easterbrook and Fischel argued in The Economic Structure of Corporate Law that a diversified shareholder has "an investment in the economy as a whole and therefore wants whatever social or private governance rules maximize the value of all firms put together" and is "not interested in maximizing one firm's value if that comes out of the hide of some other corporation.” In contrast, however, Richard Booth argued that "Management duty should be thought of as owed to an undiversified stockholder and thus owed to the corporation." Richard A. Booth, Stockholders, Stakeholders, and Bagholders (or How Investor Diversification Affects Fiduciary Duty), 53 Bus. Law. 429, 434–35 (1998).

Booth in his article also offers the interesting and counter-intuitive claim in support of the use of the fictional undiversified shareholder concept that even diversified investors would prefer directors to act as though they owed their fiduciary duties solely to undiversified shareholders. He rests this claim primarily upon the argument that the widespread use of stock option compensation for senior corporate management, which in most instances places those managers in the position of relatively undiversified corporate shareholders because of the large size of those stock option positions relative to the managers' overall wealth, evidences a desire on the part of the diversified shareholders that the managers behave in accordance with the interests of undiversified shareholders.

Gregory Scott Crespi, Maximizing the Wealth of Fictional Shareholders: Which Fiction Should Directors Embrace?, 32 J. Corp. L. 381, 411 (2007) (disagreeing with Booth's argument).

I disagree with both points of view. On the one hand, as I have long argued:

In addition to being doctrinally questionable, the notion that directors owe duties to the corporate entity is inconsistent with the dominant contractarian theory of the firm.⁹¹ The insistence that the firm is a real entity is a form of reification—i.e., treating an abstraction as if it has material existence. Reification is often useful, or even necessary, because it permits us to utilize a form of shorthand—it is easier to say General Motors did so and so than to attempt in conversation to describe the complex process that actually may have taken place. Indeed, it is very difficult to think about large firms without reifying them. Reification, however, can be dangerous. It becomes easy to lose sight of the fact that firms do not do things, people do things.

In other words, the corporation is not a thing to which duties can be owed, except as a useful legal fiction.

Stephen M. Bainbridge, Much Ado About Little? Directors' Fiduciary Duties in the Vicinity of Insolvency, 1 J. Bus. & Tech. L. 335, 352–53 (2007).

On the other hand, I am dubious about whether managers have the training or expertise to manage a company in the interests of diversified investors at large. Suppose managers have come up with an idea for a new product. Do we really think they can--or should--evaluate whether selling the new product would injure competitors and thus be adverse to the interests of diversified investors?

Another way of looking at the problem is to note that corporate law is not concerned with the merits of board decisions. Instead, it is concerned with minimizing agency costs. Diversified investors have diversified away the risk of management mistakes and errors of judgment; hence, the business judgment rule. But they cannot diversify away the risk of self-dealing, which the business judgment rule does nt protect. Hence, corporate law focuses on the individual corporation rather than the universe of public corporations.

Posted at 03:30 PM in Corporate Law | Permalink | Comments (0)

The Restatement Reporters Reply

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.

Posted at 02:17 PM in Corporate Law, Guest Posts, Restatement of Corporate Law | Permalink | Comments (0)

Does Corporate Law Matter?

Robert Rhee claims to have determined that Delaware corporate law does not add value relative to that of non-Delaware states. corpgov.law.harvard.edu/2022/09/30/the But what if corporate law generally does not impact firm value across a broad spectrum of firms?

In other words, what if corporate law is not correlated (let alone causally linked) to firm performance. Instead, the purpose of corporate law might not be to improve firm performance across the board but to punish individual wrongdoers.

Put another way, given evidence that corporate governance quality metrics are not correlated to firm performance, why would we expect corporate law to be so correlated?

See, e.g., Roberta Romano, A Cautionary Note on Drawing Lessons from Comparative Corporate Law, 102 YALE L. J. 2021 (1993) (concluding that key factors affecting market performance do not correlate to corporate governance patterns); Bernard Black, Does Corporate Governance Matter? 149 U. Pa. L. Rev. 2131 (2001) (analyzing the relationship between corporate governance and market value); Mark S. Klock et al., Does Corporate Governance Matter to Bondholders?, 40 J. Fin. & Quant. Anal. 693 (2005).

Posted at 03:06 PM in Corporate Law | Permalink | Comments (0)

More on Caremark liability for cyber security lapses

Apropos the preceding post, Kevin LaCroix explains:

In the immediate aftermath of the Delaware Supreme Court’s 2019 decision in Marchand v. Barnhill, and as part of the discussion of the decision’s possible implications, one question I was asked was whether claimants might seek to assert breach of the duty of oversight claims in the context of cybersecurity and privacy issues. After all, for many companies these days, cybersecurity is mission critical. However, there are now two Delaware court decisions in which attempts to assert an oversight duty claim in the context of a cybersecurity incident have been unsuccessful.

LaCroix goes on to discuss the most recent case on point, Vice Chancellor Glasscock’s September 6, 2022 opinion in the SolarWinds case, which can be found here.

Vice Chancellor Glasscock did not hold that a claimant could never sustain a cybersecurity related oversight duty breach claim. But his opinion does contain a number of points that underscore how difficult it would be for a claimant to succeed on this theory.

He goes on to explain those points. It's a must read column.

Posted at 02:43 PM in Corporate Law | Permalink | Comments (0)

MorganStanley Board: Potential Caremark Liability?

Via Matt Levine, I learn of a SEC complaint against MorganStanley Smith Barney (MSSB):

The Securities and Exchange Commission today announced charges against Morgan Stanley Smith Barney LLC (MSSB) stemming from the firm’s extensive failures, over a five-year period, to protect the personal identifying information, or PII, of approximately 15 million customers. MSSB has agreed to pay a $35 million penalty to settle the SEC charges.

The SEC’s order finds that, as far back as 2015, MSSB failed to properly dispose of devices containing its customers’ PII. On multiple occasions, MSSB hired a moving and storage company with no experience or expertise in data destruction services to decommission thousands of hard drives and servers containing the PII of millions of its customers. Moreover, according to the SEC’s order, over several years, MSSB failed to properly monitor the moving company’s work. The staff’s investigation found that the moving company sold to a third party thousands of MSSB devices including servers and hard drives, some of which contained customer PII, and which were eventually resold on an internet auction site without removal of such customer PII. While MSSB recovered some of the devices, which were shown to contain thousands of pieces of unencrypted customer data, the firm has not recovered the vast majority of the devices.

The SEC’s order also finds that MSSB failed to properly safeguard customer PII and properly dispose of consumer report information when it decommissioned local office and branch servers as part of a broader hardware refresh program. A records reconciliation exercise undertaken by the firm during this decommissioning process revealed that 42 servers, all potentially containing unencrypted customer PII and consumer report information, were missing. Moreover, during this process, MSSB also learned that the local devices being decommissioned had been equipped with encryption capability, but that the firm had failed to activate the encryption software for years.

“MSSB’s failures in this case are astonishing. Customers entrust their personal information to financial professionals with the understanding and expectation that it will be protected, and MSSB fell woefully short in doing so,” said Gurbir S. Grewal, Director of the SEC’s Enforcement Division. ...

Without admitting or denying its findings, MSSB consented to the SEC’s order finding that the firm violated the Safeguards and Disposal Rules under Regulation S-P and agreed to pay the aforementioned penalty.

What immediately came to mind was the Marchand line of Caremark cases. Here's a good summary of the law by Seyfarth Shaw lawyers:

In its 1996 In re Caremark decision, the Delaware Court of Chancery articulated a standard of liability with respect to a board of directors’ oversight failures. The Delaware Court of Chancery explained that such oversight duties stem from a directors’ duty to act in good faith and to be “reasonably informed concerning the corporation.” Caremark, 698 A.2d at 970. The Delaware Court of Chancery concluded that in order to fulfill the obligation to be reasonably informed, the board must first assure itself “that the corporation’s information and reporting system is in concept and design adequate to assure the board that appropriate information will come to its attention in a timely manner as matter of ordinary operations.” Id. ...

In June 2019, an en banc panel of the Delaware Supreme Court clarified the pleading requirements for Caremark claims in Marchand v. Barnhill. 212 A.3d at 805. In Marchand, the Delaware Supreme Court reversed the Delaware Court of Chancery’s dismissal of Caremark claims finding that the complaint alleged facts supporting a reasonable inference that the board “failed to implement any system to monitor [the company’s] food safety performance or compliance.” Id. at 809.

The Marchand decision reiterated that the board has a duty to exercise oversight and to monitor “the corporation’s operational viability, legal compliance, and financial performance” by making a good faith “attempt to assure a reasonable information and reporting system exists” and then taking steps to monitor and oversee the system. Id. The Marchand court clarified that failures to either (i) implement reasonable systems or (ii) to monitor the existing systems are “act[s] of bad faith in breach of the duty of loyalty.” Id. In other words, implementing a system that is not reasonable under the circumstances could expose a board to liability as could the failure to monitor the system.

In Marchand, the company manufactured ice cream and, the court determined, lack a board-level system of oversight of food safety. The court described food safety as a "mission critical" component of the business, which heightened the need for board oversight. Similarly, in the subsequent Boeing case, the court zeroed in on the board's lack of oversight with respect to passenger safety, which was a mission critical concern for the airplane manufacturer.

Pertinent to MSSB's situation, cyber security is increasingly regarded as a mission critical issue. The Seyfarth Shaw memorandum continues:

... the Delaware courts have emphasized the importance of the board’s oversight duties, particularly with respect to mission-critical company issues and risks. Possible inadequacies of oversight systems in these mission critical areas will likely cause courts to give added scrutiny to boards oversight of them. Cyber-security poses an area of increasing risk for companies. With the progressive sophistication of cyber criminals in disrupting operations to extort payment, cyber-security is likely to be considered a significant risk for most businesses. Board oversight of cyber-security risks and risk mitigation policies is important for most companies and their directors.

In fact, in a recent Caremark case, the Delaware Court of Chancery acknowledged that cyber-security was “an area of consequential risk that spans modern business sectors.” Firemen’s Ret. Sys. of St. Louis on behalf of Marriott Int’l, Inc. v. Sorenson, No. CV 2019-0965-LWW, 2021 WL 4593777, at *11 (Del. Ch. Oct. 5, 2021).

As Levine explains, this is particularly true for banks:

In recent years it has been popular for investment bank executives to say that they were becoming tech companies: They were hiring developers, building apps, talking about big data.

It may be that Caremark claims against MSSB will be barred by the statute of limitations. It sounds like the problem occurred in 2016 and that MSSB began remediation efforts sometime in 2017. Not my area of expertise.

At the very least, however, it would make a good exam question.

Posted at 12:11 PM in Corporate Law | Permalink | Comments (1)

When does appointment of a special litigation committee constitute a concession that demand would be futile?

Thanks to The Chancery Daily, I learned about an interesting new Delaware Chancery Court decision dealing with the demand requirement in shareholder litigation: Rowan v. Infinity Q Capital Management LLC, 2002 WL 4127578 at *5 (Del. Ch. Sept. 12, 2022).

The Chancery Daily explains:

Plaintiff mutual fund investor brought derivative claims on behalf of the Delaware statutory trust that issues the fund's securities, alleging that members of the board of trustees and others breached contractual and fiduciary duties, leading to the fund's collapse.

Prior to plaintiff's filing of his complaint, the board had appointed a new trustee and created a special litigation committee ("SLC") composed solely of the new trustee, with authority to investigate potential claims and to "supervise any . . . prosecution, settlement, or other disposition of such Claims." After the complaint was filed, the trust, as nominal defendant, moved to dismiss for failure to plead demand futility.

Plaintiff asserted that, although the full board had authorized the motion, it lacked authority to do so because it had delegated its authority over derivative claims to the SLC.

The Court denies the motion for lack of standing in this Opinion, finding plaintiff raised particularized allegations allowing an inference that, by appointing a special litigation committee comprising a single, unconflicted new director, the non-committee trustees conceded demand futility as to the board as a whole and delegated control over procedural defenses to the SLC.

If plaintiff makes demand on the board before filing suit, that action is deemed a concession that demand was required.[1] Note that making demand only concedes the board’s ex ante good faith and independence, such that plaintiff may not subsequently argue that demand was futile. If the board refuses the demand, the plaintiff is entitled to argue that the board’s refusal was wrongful, although the applicable standard is the business judgment rule, which we will see below is a challenging standard for the plaintiff to meet.[2]

Conversely, however, appointment by the board of a special committee to investigate the challenged transaction is not automatically deemed a concession that demand would be futile. In Seminaris v. Landa,[3] the board responded to a SEC investigation by appointing a special committee to investigate the conduct that had triggered the SEC’s inquiry. Three weeks late a shareholder-plaintiff filed a derivative suit alleging breaches of fiduciary duty in connection with that conduct without making demand. The full board instructed the extant special committee to investigate plaintiff’s complaint. The committee recommended dismissal of the plaintiff’s lawsuit and the defendants moved for dismissal on that basis. Plaintiff argued that appointing the special committee was a concession that demand would be futile and should therefore be excused. (As discussed below, cases in which demand is deemed futile are reviewed under a more shareholder-plaintiff friendly standard than those in which it is required.)

The Seminaris court held that “a disinterested board of directors does not waive its right to control derivative litigation merely by delegating that control to a special committee.”[4] Accordingly, the court went on to determine whether plaintiff had adequately pled demand futility: “To demonstrate that the . . . Board conceded demand futility, plaintiff must allege particularized facts to support a factual determination that the board intended to concede demand.”[5] The court determined that plaintiff had failed to do so.

In contrast, in Abbey v. Computer & Commun. Tech. Corp.,[6] plaintiff made demand before filing suit. Several weeks later, having not received a response, plaintiff filed her derivative suit. The board then appointed a one person special litigation committee. The court held that “that by divesting itself of any power to make a decision on the pending suit, and by adding a new and independent director and by designating him as a special Litigation Committee of one with the final and absolute authority to make the decision on behalf of the corporation, the incumbent board of directors, in effect, conceded that the circumstances alleged in the complaint justified the initiation of the suit by the plaintiff.”[7]

In Rowan v. Infinity Q Capital Management, LLC,[8] the Chancery Court reviewed the relatively sparse precedents on point—including Seminaris and Abbey—and concluded that there are “at least two ways a plaintiff can plead a board's creation of a special litigation committee conceded futility and delegated the ability to bring a procedural motion: (a) a sequence of events in which the board created a fully empowered committee after the complaint was filed, or (b) other particularized facts, perhaps where the committee was created before the complaint was filed but was comprised of new board members that do not labor under an apparent interest that other board members do.”[9] Accordingly, “the most prudent course of conduct for a corporation is to first file a motion to dismiss for failure to make demand before appointing a special litigation committee to investigate the allegations.”[10]

Concern for structural bias presumably influenced this line of cases. Presumably the Delaware courts assume a non-conflicted board would itself review the plaintiff’s allegations rather than delegating them to new, unconflicted directors. In turn, the new directors will be structurally biased in favor of those who appointed them.

Continue reading "When does appointment of a special litigation committee constitute a concession that demand would be futile?" »

Posted at 03:18 PM in Corporate Law | Permalink | Comments (0)

Keith Paul Bishop spots a corporate law mystery

Keith Paul Bishop spots a mystery: why is there a right to a jury trial when the corporation brings a complaint seeking damages for breach of fiduciary duty but not if that same allegations are brought derivatively. https://t.co/2OilerqSyE
— Steve Bainbridge (@PrawfBainbridge) September 10, 2022

Posted at 03:14 PM in Corporate Law | Permalink | Comments (0)

Corporate Law and the Utopian Fallacy

New paper by Beate Sjåfjell, Re-embedding the Corporation in Society and on Our Planet: Company Law as a Vehicle for Change (January 13, 2022). Chapter 12 in Beate Sjåfjell, Carol Liao and Aikaterini Argyrou (eds), Innovating Business for Sustainability: Regulatory Approaches in the Anthropocene (Edward Elgar Publishing). Available at SSRN: https://ssrn.com/abstract=4008062

The corporation needs to be ‘re-embedded’ in society and on our planet. Business is an integral element of the disembedding from society, through the way the corporation, a dominant legal form for undertaking business, has been conceptualised in the dominant legal-economic theories. This has formed the basis for and has been exacerbated through the social norm of shareholder primacy. Re-embedding the corporation requires a reconceptualisation of corporation’s role in society and the environment, and challenging a deeply gendered approach not only within business but also within sustainability science. Employing an interdisciplinarity feminist sustainability perspective, I make the case for using company law as a lever to re-embed the corporation through the embedding into the core of company law, key societal concepts of sustainability, drawing on sustainability research. The reform proposals concentrate on EU law but the reform ideas and the basis for them are of global relevance.

Sorry, but I don't buy it. Compare and contrast with D. Gordon Smith, The Dystopian Potential of Corporate Law (March 2007). Univ. of Wisconsin Legal Studies Research Paper No. 1040, Available at SSRN: https://ssrn.com/abstract=976742.

The community of corporate law scholars in the United States is fragmented. One group, heavily influenced by economic analysis of corporations, is exploring the merits of increasing shareholder power vis-a-vis directors. Another group, animated by concern for social justice, is challenging the traditional, shareholder-centric view of corporate law, arguing instead for a model of stakeholder governance. The current disagreement within corporate law is as fundamental as in any area of law, and the debate is more heated than at any time since the New Deal.

This paper is part of a debate on the audacious question, Can Corporate Law Save the World? In the first part of the debate, Professor Kent Greenfield builds on his book, THE FAILURE OF CORPORATE LAW: FUNDAMENTAL FLAWS AND PROGRESSIVE POSSIBILITIES, offering a provocative critique of the status quo and arguing that corporate law matters to issues like the environment, human rights, and the labor question.

In response, Professor Smith contends that corporate law does not matter in the way Professor Greenfield claims. Corporate law is the set of rules that defines the decision making structure of corporations, and reformers like Professor Greenfield have only two options for changing corporate decision making: changing the decision maker or changing the decision rule. More specifically, he focuses on board composition and shareholder primacy. Professor Smith argues that changes in corporate law cannot eradicate poverty or materially change existing distributions of wealth, except by impairing the creation of wealth. Changes in corporate law will not clean the environment. And changes in corporate law will not solve the labor question. Indeed, the only changes in corporate law that will have a substantial effect on such issues are changes that make the world worse, not better.

I stand with Gordon.

Posted at 02:20 PM in Corporate Law, Corporate Social Responsibility | Permalink | Comments (2)

Still more on the requirement that board of director decisions be informed

Mark Twain and the Hale & Norcross Mining Case which is one of the ur-precedents on the requirement that board of director decisions be informed. https://t.co/NoL4pivbqk
— Steve Bainbridge (@PrawfBainbridge) August 23, 2022

Posted at 12:46 PM in Corporate Law | Permalink | Comments (0)

Keith Paul Bishop on the origins of the requirement that board decision be informed

He writes:

In Fox v. Hale & Norcross Silver Mining Co., 108 Cal. 369, 41 P. 308 (1895), the trial court held directors liable for a diversion of funds by the president of the corporation to himself. The court said: “None of the directors, however, had any substantial interest in the corporation.…Being chosen in this way [i.e., by the president and substantial shareholders] and receiving no compensation for their services, except $5 for each meeting of the board at which they attended, they gave to the affairs of the company the amount of attention that might have been expected. Several of them seemed to have known next to nothing about the operations at the mine. While others took a little more trouble to keep themselves informed in a general way about the mining of ores and the price paid for reduction, they seem one and all to have entrusted the management of the entire business to the president, Levy, and to the superintendent of the mines; and, if these officers, by abuse of their trust, caused the loss and damage to the mining company which the court has found, the evidence warrants the conclusion that the directors were at least guilty of gross negligence.” Despite this statement, the Supreme Court reversed the judgment against the directors on the technical pleading point that the complaint had alleged only that they were guilty of fraud, and not of negligence.

Posted at 12:36 PM in Corporate Law | Permalink | Comments (0)