ProfessorBainbridge.com

Guest Post: Does Van Gorkom's requirement of an informed decision survive Corwin?

My friend Robert T Miller of the University of Iowa law school sent along this email in response to my post Does Van Gorkom's requirement of an informed decision survive Corwin? I'm stumped:

I stand by my conclusion in the article on Van Gorkom. I get there primarily because I don’t read Stroud as expansively as you do. In addition, I’m not completely clear what meaning you’re attributing to Singh, but as I read it, there’s nothing in Singh that contradicts what I said in the article. And, to be clear, my article does not predate Singh. Singh was decided in 2016, and I wrote the Van Gorkom article in 2017. I cite Singh twice in the article, in nn. 631 and 676.

To start with Stroud, I read the case to mean that, in fulfilling its duty of candor, a board need not draw legal conclusions such, “We breached our duty of care.” Nevertheless, to fulfill its duty of candor, it must disclose all the material facts in its possession, including any facts that tend to show that it breached its duty of care. That is, the board does not need to say, “We were grossly negligent,” even if it actually believes that. But the board does need to say (provided this is true), “We met for one hour to discuss the merger, but we spent most of the time talking about baseball.” I believe the rule here is same as it is under the federal securities laws.

As to Singh, I read it as merely correcting VC Parson’s misunderstanding of Corwin in the opinion below, which is In re Zales Corp. Stockholders Litig., 2015 WL 6551418 (Del. Ch. 2015). That is, in Corwin, the Supreme Court talked about “the business judgment rule” applying after an uncoerced, fully-informed shareholder vote (compare how the court talked in Unocal).Such language, however, is ambiguous. On one reading, it means this: in a Revlon transaction, after an effective Corwin vote, the standard of review shifts from Revlon to the BJR, in the sense that the court will review the board’s actions from the beginning asking not whether the board took reasonable steps to get the best price reasonably available but whether the board breached its duty of loyalty or its Van Gorkom duty of care. On another reading, the language in Corwin means this: in a merger that would be reviewed under either Revlon or the BJR, after an effective Corwin vote, the standard of review shifts to the rational business purpose test, the standard of review that applies when the BJR is satisfied (i.e., there has been no breach of the board’s duties of loyalty or care). In the opinion below, the Court of Chancery had read Corwin the first way at the re-argument phrase. What Strine is saying in Singh is that this reading is a mistake. It is the second interpretation of Corwin that is correct: after an effective Corwin vote, the suit should be dismissed unless the merger lacks a rational business purpose (i.e., amounts to waste).

To turn to your problem, then, my answer is the following. The board’s duty of candor requires that it state all material facts in its possession in the proxy but not that it state legal conclusions such as, “We breached our duty of care.” If the board really was grossly negligent in approving the merger, then the board must state the material facts, which will support the conclusion that it breached its duty of care. If the board fulfills this duty and the shareholders vote to approve the merger anyway, then the vote will be effective under Corwin. Hence, the cause of action for breach of the duty of care will be extinguished, and the only possible claim is for waste. That claim will fail, and the suit will be dismissed.

If the board fails to state all the material facts about its process, however, then the Corwin vote will not be effective. As a result, the shareholders may sue for any breach the board committed, including a breach of the duty of care. Nevertheless, if the corporation has a 102(b)(7) charter provision, any claim sounding in the duty of care will be immediately dismissible under Malpiede v. Townsend. In the extremely unlikely event that the corporation does not have a 102(b)(7) provision, however, the shareholder’s suit will go forward, and the directors will be liable in damages for their breach of the duty of care. This is the same conclusion I reached in the Van Gorkom article.

We are disagreeing here, I think, primarily because of our disagreement about Stroud. If I follow you, you’re reading Stroud as meaning that a board’s duty of candor does not include stating material facts in its possession that tend to show it breached its fiduciary duties. If it were right, then a board could breach its duty of care, not disclose the material facts about the breach in the proxy, get an effective Corwin vote on the basis of that proxy, and then use that Corwin vote to extinguish the claim based on its duty of care. In my view, that would be an outrageous result, and, as I say, I don’t think that’s the law. I note too that your example concerns breaches of the duty of care related to the approval of the merger. Part of what I’m talking about in the passage you quote concerns breaches of the duty of candor—i.e., it goes to why the proxy omitted to state material facts. Such omissions can arise either from breaches of the duty of loyalty or from the duty of care. Those questions get more complicated, but, as I saw, I understand your example as applying to the simpler issue of a breach of the duty of care in the approval process of the merger.

That was very helpful.

If Company A owns Company B, which acts badly, can Company A shareholders bring an oversight claim against Company A for failing to monitor Company B?

A buddy sent along this email: "Company A owns Company B, which acts badly. Can Company A shareholders bring an oversight claim against Company A for failing to monitor Company B?"

To which I responded:

Yes.  Caremark itself involved misconduct by a subsidiary. Caremark’s agreement with the government “required a Caremark subsidiary to enter a guilty plea to two counts of mail fraud.” In re Caremark Intern. Inc. Derivative Litig., 698 A.2d 959, 965 n.10 (Del. Ch. 1996). In In re Yahoo! Inc. Shareholder Derivative Litig., 153 F. Supp. 3d 1107, 1121 (N.D. Cal. 2015), the court found that plaintiffs had failed to state a Caremark claim with respect to Yahoo’s board’s failure to monitor a subsidiary, but the court gave no reason to think that such a claim was bad law. See also Oklahoma Firefighters Pension & Ret. Sys. v. Corbat, Civil Action No. 12151-VCG, 2017 WL 6452240, at *18 (Del. Ch. Dec. 18, 2017) (rejecting Caremark claim based on alleged oversight failures of defendants in connection with subsidiary's decision to engage in business venture with third party that resulted in large losses due to third party's fraud); Martin Petrin, Assessing Delaware's Oversight Jurisprudence: A Policy and Theory Perspective, 5 Va. L. & Bus. Rev. 433, 480 (2011) (explaining that “it appears that Caremark claims may be used to hold directors of a parent company liable for failing to oversee conduct that occurred in a subsidiary-a prospect that seems particularly unsettling for directors of large corporate conglomerates”).

Does Van Gorkom's requirement of an informed decision survive Corwin? I'm stumped.

Assume the following:

1. The board of directors is approached by a private equity fund-backed management buyout group.
2. The board approves the transaction but, in doing so, was grossly negligent in failing to inform themselves of all information reasonably available to them.
3. The board then puts the proposal to a vote of the shareholders. The shareholder vote is uncoerced. The proposal is approved by a substantial majority of the disinterested shareholders.
   1. But the proxy statement did not disclose that the directors had been grossly negligent in failing to inform themselves of all information reasonably available to them.
4. Has the shareholder vote satisfied Corwin?
   1. See Stroud v. Grace, 606 A.2d 75, 84 n.1 (Del. 1992) ("We recognize the long-standing principle that to comport with its fiduciary duty to disclose all relevant material facts, a board is not required to engage in “self-flagellation” and draw legal conclusions implicating itself in a breach of fiduciary duty from surrounding facts and circumstances prior to a formal adjudication of the matter. Nonetheless, when a board allegedly breaches its fiduciary duties, we will not uphold shareholder ratification unless the board discloses all material facts relevant to the issue at hand.").

Assuming Corwin applies, is there any room left for rebutting the business judgment rule by showing that the directors failed to satisfy the informed decision requirement laid out by Van Gorkom? Or is that requirement a dead letter?

On the basis of Leo Strine's decision in Singh v. Attenborough, 137 A.3d 151 (Del. 2016), I think the answer to the former is no:

We affirm the judgment of the Court of Chancery solely on the basis of its decision on reargument of October 29, 2015, finding that a fully informed, uncoerced vote of the disinterested stockholders invoked the business judgment rule standard of review. But, we note that the reargument opinion's decision to consider post-closing whether the plaintiffs stated a claim for the breach of the duty of care after invoking the business judgment rule was erroneous. Absent a stockholder vote and absent an exculpatory charter provision, the damages liability standard for an independent director or other disinterested fiduciary for breach of the duty of care is gross negligence, even if the transaction was a change-of-control transaction.Therefore, employing this same standard after an informed, uncoerced vote of the disinterested stockholders would give no standard-of-review-shifting effect to the vote. When the business judgment rule standard of review is invoked because of a vote, dismissal is typically the result. That is because the vestigial waste exception has long had little real-world relevance, because it has been understood that stockholders would be unlikely to approve a transaction that is wasteful.

On the other hand, I take it that Robert Miller disagrees:

Even after Corwin, in the absence of a Section 102(b)(7) provision in the corporate charter, a plaintiff-stockholder may argue post-closing that the stockholder vote was not fully informed, and if the plaintiff succeeds on this score, the directors would be liable in monetary damages for any breaches of their duty of care, including under Revlon. In the presence of a Section 102(b)(7) provision, the plaintiff-stockholder has to argue that any material misstatement or omission in the disclosure resulted from a breach of the board's duty of loyalty--a claim that, in a third-party transaction in which the directors were not otherwise interested--is very unlikely to succeed. See Larkin v. Shah, C.A. No. 10918-VCS, 2016 WL 4485447, at *20 (Del. Ch. Aug. 25, 2016). The upshot is that, even after Corwin, Section 102(b)(7) remains very important in insulating directors from post-closing actions for damages in merger cases.

Robert T. Miller, Smith v. Van Gorkom and the Kobayashi Maru: The Place of the Trans Union Case in the Development of Delaware Corporate Law, 9 Wm. & Mary Bus. L. Rev. 65, 219 n.676 (2017). But note that his article pre-dated Singh.

I welcome comments, but prefer not to get speculation. Cites preferred.

Update: We got a great response from Robert Miller. Here.

Recommended Reading: Roe and Shapira's "The Power of the Narrative in Corporate Lawmaking"

A new paper by Mark Roe and Roy Shapira makes some very valuable contributions to the debate over short-termism and, more important, to the way we understand corporate and securities law debates:

This Article explores the role of narrative power. Some ideas are better at being popular than others. The concept of pernicious stock market short-termism has three strong qualities that make its narrative power formidable: (1) connotation — the words themselves tell us what is good (reliable long-term commitment) and what is not (unreliable short-termism); (2) category confusion — disparate types of corporate misbehavior, such as environmental degradation and employee mistreatment, are mislabeled as being truly and primarily short-termism phenomena emanating from truncated corporate time horizons (when they in fact emanate from other misalignments), thereby making us view short-termism as even more rampant and pernicious than it is; and (3) confirmation — the idea is regularly repeated, because it is easy to communicate, and often boosted by powerful agenda-setters who benefit from its repetition.

The Article then highlights the real-world implications of narrative power — powerful narratives can be more certain than the underlying evidence, thereby leading policymakers astray.

Roe, Mark J. and Shapira, Roy, The Power of the Narrative in Corporate Lawmaking (August 24, 2020). Available at SSRN: https://ssrn.com/abstract=3703882 or http://dx.doi.org/10.2139/ssrn.3703882

There is no such thing as shareholder democracy to reclaim

There's a new paper out, Back to the Future? Reclaiming Shareholder Democracy Through Virtual Annual Meetings (August 26, 2020), by Yaron Nili and Megan Shaner, which argues that:

From demanding greater executive accountability to lobbying for social and environmental policies, shareholders today influence how managers run American corporations. In theory, shareholders exert that influence through the annual meeting: a forum where any shareholder, large or small, can speak their mind, engage with the corporation’s directors and managers, and influence each other. But today’s annual meetings, where a widely diffused group of owners often vote by proxy, are largely pro forma: only handful of shareholders attend the meeting and voting results are largely determined prior to the meeting. In many cases, this leaves Main Street investors’ voice unspoken for.

But modern technology has the potential to resurrect the annual meeting as the deliberative convocation and touchstone of shareholder democracy it once was. COVID-19 has forced most American corporations to hold their annual meetings virtually. Virtual meetings allow shareholders to attend meetings at a low cost, holding the promise of re-engaging retail shareholders in corporate governance. If structured properly, virtual meetings can reinvigorate the annual meeting, reviving shareholder democracy while maintaining the efficiency benefits of proxy voting.

It's a well written and researched paper, but I don't believe either that there ever was such a thing as shareholder democracy or that we should try to create shareholder democracy. (To be clear, I'm talking here about public corporations, not close corporation).

As to the former, the separation of control and the concomitant limitation of shareholder participation in corporate decision making is not new:

According to Berle and Means's version of economic history, dispersed ownership arose as a consequence of the development of large capital-intensive industrial corporations during the late nineteenth century. These firms required investments far larger than a single entrepreneur or family could provide, which could be obtained only by attracting funds from many investors. Because small investors needed diversification, even very wealthy individuals limited the amount they would put at risk in any particular firm, further fragmenting share ownership. The modern separation of ownership and control was the direct result of these forces, or so the story goes.

Professor Walter Werner aptly referred to Berle and Means's account as the “erosion doctrine.” According to their version of history, there was a time when the corporation behaved as it was supposed to:

The shareholders who owned the corporation controlled it. They elected a board of directors to whom they delegated management powers, but they retained residual control, uniting control and ownership. In the nation's early years the states created corporations sparingly and regulated them strictly. The first corporations, run by their proprietors and constrained by law, exercised state-granted privileges to further the public interest. The states then curtailed regulation . . . and this Eden ended. The corporation expanded into a huge concentrate of resources. Its operation vitally affected society, but it was run by managers who were accountable only to themselves and could blink at obligations to shareholders and society. The erosion doctrine, however, rested on a false account of the history of corporations. Werner explained that economic separation of ownership and control in fact was a feature of American corporations almost from the beginning of the nation:

Banks, and the other public-issue corporations of the [antebellum] period, contained the essential elements of big corporations today: a tripartite internal government structure, a share market that dispersed shareholdings and divided ownership and control, and tendencies to centralize management in full-time administrators and to diminish participation of outside directors in management.

In contrast to Berle and Means's account, which rested on technological changes during the nineteenth century, this alternative account rests on the early development of secondary trading markets. Such markets existed in New York and Philadelphia by the beginning of the nineteenth century. The resulting liquidity of corporate stock made it an especially attractive investment, which in turn made selling stock to the public an attractive financing mechanism. Stocks were purchased by a diversified and dispersed clientele, including both institutions and individuals. The national taste for speculation also played a part in the early growth of the secondary trading markets and, in turn, to dispersal of stock ownership. As a result of these economic forces, ownership and control separated not at the end of the nineteenth century, but at its beginning.

If this version of history is correct, [and it is] there never was a time in which unity of control and ownership was a central feature of U.S. corporations. To the contrary, it appears that ownership and control separated at a very early date.

Stephen M. Bainbridge, The Case for Limited Shareholder Voting Rights, 53 UCLA L. Rev. 601, 620–21 (2006). 

As to the second point, I have long argued that:

While notions of shareholder democracy permit powerful rhetoric, corporations are not New England town meetings. Put another way, we need not value corporate democracy simply because we value political democracy.

Stephen M. Bainbridge, Unocal at 20: Director Primacy in Corporate Takeovers, 31 Del. J. Corp. L. 769, 812 (2006).

More recently, I have argued that:

Who decides what products a company should sell, what prices it should charge, and so on? Is it the board of directors, the top management team, or the shareholders? In large corporations, of course, the traditional answer is the top management team operating under the supervision of the board. As for the shareholders, they traditionally have had no role in these sort of operational decisions.

This allocation of decision-making power follows from the basic principle that public corporations are not shareholder democracies. Although shareholders nominally own the corporation, they possess very few control rights normally associated with ownership. Instead, corporate law assigns virtually plenary decision-making authority to the board of directors and the subordinate managers to whom the board properly delegates authority.

This allocation of authority is essential if the corporation is to be run efficiently. Just as a large city cannot be run as a New England town meeting, a large corporation is a poor candidate for direct democracy. There simply are too many widely dispersed shareholders who have varying degrees of information about the company, differing goals and investment time horizons, and competing ideas about optimal business practices for their preferences to be aggregated efficiently. Accordingly, state corporate law traditionally has given primary decision-making authority to the board and the managers to whom the board properly delegates authority. As the Delaware General Corporation Law puts it, the “business and affairs” of a corporation “shall be managed by or under the direction of a board of directors.”

Stephen M. Bainbridge, Revitalizing SEC Rule 14a-8's Ordinary Business Exclusion: Preventing Shareholder Micromanagement by Proposal, 85 Fordham L. Rev. 705, 707–08 (2016).

My longest and most detailed argument against policies designed to promote shareholder democracy is contained in Chapter 1 of my book The New Corporate Governance in Theory and Practice. In Chapter 5, I return to the case against shareholder democracy by exploring and rejecting proposals designed to promote shareholder activism.

In sum, there was no Golden Age of shareholder democracy. There simply is nothing there to reclaim. And that's a very good thing.

Under California law, shareholder inspection rights are not an internal affair

Keith Paul Bishop writes:

In this recent post, UCLA Law School Professor Stephen Bainbridge discusses Vice Chancellor  J. Travis Laster's recent ruling that "[s]tockholder inspection rights are a core matter of internal corporate affairs."  2020 Del. Ch. LEXIS 264.  He notes that he has "long understood (and taught) that shareholder inspection rights are a rare exception to the internal affairs doctrine".  ...

I would add that the California Court of Appeal is in agreement with Professor Bainbridge's understanding and teaching.  In Valtz v. Penta Investment Corp., 139 Cal. App. 3d 803, 807 (1983), the Court held that Section 1600 (governing the right to inspect the shareholder records):

"However, even assuming the validity of this internal affairs doctrine, Penta's argument fails because section 1600 does not address an internal affair; the inspection of shareholder lists is a right incidental to the ownership of stock, affects the relationship between corporation and shareholder, and is thus subject to regulation by statute where the corporation does business."

See my article, California Court of Appeal Applies California Inspection Rights to Delaware Corporation, 17 CEB California Business Law Reporter 168 (1996).

A Delaware business corporation cannot opt out of the shareholder wealth maximization norm in its certificate of incorporation

I am going back and forth with a friend and fellow Business Associations teacher as to whether it is possible for a Delaware business corporation to opt out of the shareholder wealth maximization norm in its certificate of incorporation. As you may have already guessed from the title of this post, I am quite sure that the answer is a resounding no.

(I note, in passing, that the fact that I am helping my friend even though s/he uses the wrong BA casebook, speaks volumes. Don't you think?)

My analysis starts with Sterling v. Mayflower Hotel Corp, 93 A.2d 107, 118 (Del. 1952), which held that “the stockholders of a Delaware corporation may by contract embody in the charter a provision departing from the rules of the common law, provided that it does not transgress a statutory enactment or a public policy settled by the common law or implicit in the General Corporation Law itself.” That command must be read in conjunction with Chancellor Chandler's eBay opinion, which held that:

Jim and Craig opted to form craigslist, Inc. as a for-profit Delaware corporation and voluntarily accepted millions of dollars from eBay as part of a transaction whereby eBay became a stockholder. Having chosen a for-profit corporate form, the craigslist directors are bound by the fiduciary duties and standards that accompany that form. Those standards include acting to promote the value of the corporation for the benefit of its stockholders. The “Inc.” after the company name has to mean at least that.

eBay Dom. Holdings, Inc. v. Newmark, 16 A.3d 1, 34 (Del. Ch. 2010) (emphasis in the original). If that is not a clear statement that shareholder wealth maximization is "a public policy settled by the common law" I don't know what it is.

I would next move on to Siegman v. Tri-Star Pictures, Inc., CIV. A. 9477, 1989 WL 48746, at *8 (Del. Ch. May 5, 1989), which held that an amendment to the articles that “would eliminate or limit the liability of Tri-Star directors for breach of their fiduciary duty of loyalty” is “proscribed by § 102(b)(7).” 

I note that the Tri-Star case forced the legislature to adopt DGCL 122(17) to allow provisions in the articles that renounce specified corporate opportunities. But 122(17) does not speak to the duties at issue under eBay et al.

Accordingly. “there is substantial reason to doubt whether the Delaware Secretary of State would accept for filing a certificate of incorporation (other than for a benefit corporation) that included an expressly non-profit-maximizing mission.” David B. Guenther, The Strange Case of the Missing Doctrine and the "Odd Exercise" of Ebay: Why Exactly Must Corporations Maximize Profits to Shareholders?, 12 Va. L. & Bus. Rev. 427, 484 (2018).

Professor Guenther goes on to opine that:

Chancellor Chandler's language in eBay suggests that a non-profit-maximizing purpose may be invalid per se, regardless of whether shareholders have approved such purpose or embodied it in the corporate charter. The rights plan struck down in eBay, it must be recalled, had previously been approved by 71.6% - a supermajority - of craigslist's shareholders. If eBay is good law, whether shareholders of a Delaware for-profit corporation can simply “opt out” in the corporate charter from eBay's mandate to maximize profits appears unsettled in Delaware law.

Id. at 485.

Likewise, Larry Hammermesh and Jack Jacobs (who know a thing or two about Delaware law) opine that “we maintain that for an investor who has not expressly manifested a contrary preference, the purpose of the Delaware business corporation is maximization of the wealth of its stockholders. We further maintain that this is at  least the default rule, and earnestly doubt that this rule could be changed even in the certificate of incorporation of a traditional corporation.” Lawrence A. Hamermesh & Jack B. Jacobs, Lyman Johnson's Invaluable Contribution to Delaware Corporate Jurisprudence, 74 Wash. & Lee L. Rev. 909, 933–34 (2017).

Additionally, as Joan Heminway has pointed out:

Professor Stephen Bainbridge's academic work in analyzing anti-takeover devices and non-shareholder constituency statutes also casts doubt on the validity of private ordering that displaces the shareholder wealth maximization norm,⁶⁶ a norm that he argues is both the law and circumstantially compelled as an essential attribute of the for-profit corporation.⁶⁷ Specifically, Professor Bainbridge opines on the potential invalidity of “shark repellents”--in effect, charter-based rejections of the shareholder wealth maximization norm in response to unsolicited business combinations--as a form of private ordering involving a significant alteration of the directors' fiduciary duties.

[S]tate law arguably does not permit corporate organic documents to redefine the directors' fiduciary duties. In general, a charter amendment may not derogate from common law rules if doing so conflicts with some settled public policy. In light of the well-settled shareholder wealth maximization policy, nonmonetary factors charter amendments therefore appear vulnerable.

Joan MacLeod Heminway, Shareholder Wealth Maximization As A Function of Statutes, Decisional Law, and Organic Documents, 74 Wash. & Lee L. Rev. 939, 962 (2017).

She kindly cites: Stephen M. Bainbridge, Interpreting Non-Shareholder Constituency Statutes, 19 PEPP. L. REV. 971, 985 (1992) (questioning whether the law permits private ordering in derogation of director fiduciary duties and other common law rules); Stephen M. Bainbridge, Director Primacy: The Means and Ends of Corporate Governance, 97 NW. U. L. REV. 547, 575-77 (2003) (“[S]hareholder wealth maximization is not only the law, but also is a basic feature of corporate ideology.”).

All of which seems to me to be reinforced by Delaware’s adoption of the public benefit corporation option. If somebody wants a Delaware corporation that has a purpose other than shareholder wealth maximization, they have to go the B Corp route.

The American Law Institute is going to try writing a Restatement of Corporate Governance. Again. Oh joy.

It somehow escaped my attention that the American Law Institute is going to try writing a Restatement of the Law of Corporate Governance. Because they did such a good job the first time?

My article Independent Directors and the ALI Corporate Governance Project, 61 Geo. Wash. L. Rev. 1034 (1992), explored the hash the ALI made of the project the first time they tried.

The first attempt foundered. It was ultimately downgraded from a Restatement to a set of Principles, which have proven almost completely irrelevant to the development of corporate law in the intervening decades. Put bluntly, it has been almost entirely without influence.

The Project floundered because of the competing interests of the various voting blocks within the ALI.  The ALI prides itself on being, in the words of its then-President, “analytical and impartial.”  In fact, however, the process by which the project took shape most closely resembled the rough-and-tumble politics of a state legislature.

Two voting groups within the ALI—academics within the law and economics school and corporate practitioners—strongly resisted much of the Project. Law and economics scholars tended to oppose mandatory rules, be skeptical of the utility of independent directors, and resist attempts to expand the scope of judicial review of management actions. Between the steady barrage of critical academic commentary they directed at the Project and their growing strength within the ALI, their influence gradually began to be felt.  For example, Tentative Draft No. 2 strongly rejected the notion that market forces alone will result in the creation of effective monitoring systems.  In contrast, the Final Draft significantly softened and scaled back the discussion of market forces.

While resistance from the law and economics community undoubtedly played an important part in shaping the Project’s final form, the critical opposition ultimately came from corporate practitioners. Many corporate practitioners undoubtedly perceived legitimate policy objections to the Project, but there was another force at work: self-interest. In the long run, a lawyer’s self-interest points towards expansive judicial review.  Rational members of the plaintiff’s bar prefer rules throwing open the courthouse doors. So too should rational litigators within the corporate bar, given that defending lawsuits is almost as profitable as bringing them in the first instance. Even transactional lawyers have a strong interest in frequent judicial review of their client’s conduct, given that it is the threat of litigation that makes transactional lawyers necessary to those clients. Because most observers believed that the Project would significantly increase the amount of corporate litigation, long-run self-interest thus should have led practitioners to support the Project.

Short-run self-interest, however, cut the other way.  Many senior corporate executives strongly opposed the Project.  Nor did they fail to make the corporate bar aware of their views.  Indeed, it was alleged “that corporations were hiring members of the ALI to represent their interests in that body’s deliberations and that they were removing their legal business from law firms with partners who were sympathetic to the ALI’s pro-litigation outlook.”  If so, short-run self-interest argued for keeping one’s clients happy by voting as those clients wished.

The ALI’s leadership apparently believed that much of the opposition to the Project within the Institute arose from this source. Prior to the 1992 annual meeting, for example, President Perkins wrote that it was “critical that our final deliberations not be subject to the charge of a skewed representation, weighted toward any particular interest group.”  That he felt it necessary to further warn the membership not to vote unless they had “the stomach for voting in a way that an important client might not like”  strongly suggests that at least some members did not leave their clients’ interests at the door.

To understand the practicing bar’s opposition to the Project we thus must first understand the business community’s opposition. Again, much of the opposition undoubtedly proceeded from legitimate policy concerns. Many executives were concerned that the derivative suit rules, for example, would increase the number of strike suits, resulting in greater costs.  Others thought the ALI should be restating existing law, rather than making new law.  Some objected to the lack of flexibility in the Project’s various provisions.  Still others thought the Project’s drafters misunderstood the corporate enterprise.  In view of the ALI’s prestige and the widespread acceptance earlier restatements had received from courts, the business community undoubtedly feared that what it saw as policy missteps would quickly become law. 

Here too, however, self-interest no doubt also played a part. Unlike most ALI projects, the corporate governance project directly affected the prerogatives and pocketbooks of senior corporate managers. Despite all the denials and qualifications offered by the Project’s proponents, increasing management accountability—and thus management’s liability exposure—was the Project’s central goal

Not surprisingly, much of the business community’s opposition centered on the Project’s liability provisions.  Early drafts of the Project’s substantive provisions would have significantly increased the likelihood of personal liability on the part of an officer or director. Given the significantly greater risk of personal liability if those drafts had been adopted, self-interest is the most plausible explanation for the vehemence of the business community’s opposition. In turn, their opposition was reflected in the positions taken by many within the ALI.

In the face of this opposition, the Project’s drafters steadily backed down. The compromises ultimately reached generally reduced the likelihood of director and officer liability. In particular, the procedures governing derivative suits gradually moved towards the Delaware position.  The substantive provisions, including those governing interested director transactions, were likewise modified.  Perhaps as a mere incidental by-product these changes also generally introduced a greater degree of judicial deference to decisions made by independent directors.

Maybe the new Project will go more smoothly.

Maybe.

I have a sneaking feeling, however, that the new project will be the gift that keeps on giving law review article topics and that I’m going to spend much of the final years of my career takings shots at the drafts to come.

Press accounts of the Supreme Court's oral argument in Carney v. Adams, re Delaware's political balance requirement

Long time readers may recall that I wrote a WLF backgrounder on Carney v. Adams, a case challenging Delaware's requirement of a politically balanced judiciary:

Delaware’s state constitution imposes two unique requirements on the state judiciary that differentiates its courts from those of all other states. Under the bare majority rule, no more than half of the total number of the members of the state Supreme and Superior courts and the Chancery Court can be from the same political party (50 percent plus one if there is an odd number of judges). Under the major party rule, those judges must be from a “major” political party.

James R. Adams is a Delaware lawyer who has been frustrated in his search for a Delaware judicial position because he is a political independent. Adams sued Delaware Governor Carney in federal court seeking to have the Delaware provisions declared unconstitutional. Delaware argued that Adams lacked standing and, in the alternative, that the judicial-selection provisions fell within the policymaker exception to the First Amendment’s ban on conditioning state government positions on membership in a specific political party. The district court ruled for Adams on both grounds.

On appeal, the Third Circuit held that Adams had sufficiently pled Article III standing. As to the merits, the Third Circuit addressed solely the major party rule. The court nevertheless struck down both it and the bare majority rule on grounds that the latter was not severable from the former.

I argued that the Supreme Court should reverse.

The Supreme Court heard oral argument in the case yesterday. 

Bloomberg reports that:

The U.S. Supreme Court seemed likely to reinstate Delaware rules requiring a politically balanced state judiciary, which the state argues are responsible for the “First” state’s outsized role in American corporate law.

... the majority of justices during oral argument Oct. 5 signaled they didn’t seem to think the rules unconstitutionally prohibited Independent and third parties from judicial service on Delaware state courts.

Amy Howe at SCOTUSblog reports that the Court may not reach the merits. Delaware counsel argued that Adams lacked standing, but several justices pushed back strongly on that issue. 

... the justices seemed even more concerned about the broader effect that a ruling for Adams might have on other governments around the country. Alito asked Finger whether it would be any different if a governor indicated that he would never appoint someone from the opposing political party as a judge; Finger responded that it would not. Although Finger stressed that a ruling for his client would “not necessarily” have any effect on other partisan-balance rules elsewhere, it is not clear whether the justices shared his view.

Delaware Business Times is something of an outlier, speculating that law is in trouble:

In the first case of their 2020-21 term, the U.S. Supreme Court justices wasted no time needling counsel representing the state of Delaware in a case that could change the decades-old rules under which the state’s top judges are appointed.

The case, Carney v. Adams, will be closely watched by corporate America, as it impacts courts where litigation is heard for more than a million incorporated businesses, impacting shareholders, executives and more. At question is whether a state can dictate that judges be selected from major political parties and whether it can legally divide judgeships amid parties.

Are shareholder inspection rights subject to the internal affairs doctrine?

I have long understood (and taught) that shareholder inspection rights are a rare exception to the internal affairs doctrine. In our casebook, for example, we include Crane Co. v. Anaconda Co., 346 N.E.2d 507 (N.Y. 1976), in which the court applied New York law to determine whether a shareholder (that was incorporated in Illinois) was eligible to examine the stockholder list of a company incorporated in Montana. Plaintiff relied on NY BCL sec. 1315, which permits NY courts to order inspection of books and records of companies incorporated in other states.

In Juul Labs, Inc. v. Grove, CV 2020-0005-JTL, 2020 WL 4691916 (Del. Ch. Aug. 13, 2020), however, the Delaware Chancery Court held that "[s]tockholder inspection rights are a core matter of internal corporate affairs."

This is a critical holding, because the internal affairs doctrine has important constitutional implications:

“[T]he internal affairs doctrine raises important Constitutional concerns—namely, under the Fourteenth Amendment Due Process Clause, the Full Faith and Credit Clause, and the Commerce Clause.” Salzberg v. Sciabacucchi, 227 A.3d 102, 136 (Del. 2020). The Due Process Clause of the Fourteenth Amendment is implicated by the need for directors and officers “to know what law will be applied to their actions” and by the stockholders' “right to know by what standards of accountability they may hold those managing the corporation's business and affairs.” McDermott Inc. v. Lewis, 531 A.2d 206, 216–17 (Del. 1987). The Full Faith and Credit Clause “commands application of the internal affairs doctrine except in the rarecircumstance where national policy is outweighed by a significant interest of the forum state in the corporation and its shareholders.” Id. at 218 (emphasis in original) (footnote omitted). Under the Commerce Clause, a non-chartering state “ ‘has no interest in regulating the internal affairs of foreign corporations.’ ” Id. at 217. ...

The statute at issue in Juul was a California law substantially similar to New York's section 1315. As the court explained:

California is not alone in granting rights to access the books and records of foreign corporations that do business in the state. If other states could define the terms by which stockholders can inspect books and records, then a Delaware corporation could be subjected to different provisions and standards in jurisdictions around the country. Under constitutional principles outlined by the Supreme Court of the United States and under Delaware Supreme Court precedent, stockholder inspection rights are a matter of internal affairs. Grove's rights as a stockholder are governed by Delaware law, not by California law.

If widely accepted, Juul’s application of the internal affairs doctrine to shareholder inspection rights thus calls into question the constitutional validity of statutes like those of New York and California that attempt to treat shareholder inspection rights as being an exception to the internal affairs doctrine.

Juul stands in opposition to prior law that treats access to stockholder lists as a well-established exception to the internal affairs doctrine as a matter of both corporate law and conflicts of law. The Restatement (Second) of Conflict of Laws, for example, provides:

The right of a shareholder to inspect the books of a corporation poses special problems. This is an issue which can practicably be determined differently in different states. This is also an issue which, if decided differently in different states, will not seriously undermine the policy favoring uniform treatment for all shareholders of a corporation. For these reasons, a court will apply to a foreign corporation doing substantial business in the state a local statute providing for the inspection of books by a shareholder if in the court’s opinion the statute embodies an important policy.

Restatement (Second) of Conflict of Laws § 304, comment d (1971). See also Annot., 19 A.L.R.3d 869, 889-91 (1968) (noting that states have traditionally exercised authority to require disclosure of stockholder lists of foreign corporations doing business within their borders).

Although the Juul court did not directly speak to the Restatement commentary, it did address the argument that having multiple states regulating shareholder inspection rights of the same corporation would not be problematic:

An important public policy served by the internal affairs doctrine is to ensure the uniform treatment of directors, officers, and stockholders across jurisdictions. “Uniform treatment of directors, officers and shareholders is an important objective which can only be attained by having the rights and liabilities of those persons with respect to the corporation governed by a single law.” Restatement (Second) of Conflict of Laws § 302, cmt. e. “A State has an interest in promoting stable relationships among parties involved in the corporations it charters, as well as in ensuring that investors in such corporations have an effective voice in corporate affairs.” CTS Corp., 481 U.S. at 91, 107 S.Ct. 1637. Having the law of the state of incorporation govern a corporation's internal affairs “prevent[s] corporations from being subjected to inconsistent legal standards” and “provide[s] certainty and predictability,” thus “protect[ing] the justified expectations of the parties with interests in the corporation.” VantagePoint, 871 A.2d at 1112–13.

...

California's balancing of the competing interests between stockholders and the corporation differs from Delaware's. And California is not alone in granting rights to access the books and records of foreign corporations that do business in the state. If other states could define the terms by which stockholders can inspect books and records, then a Delaware corporation could be subjected to different provisions and standards in jurisdictions around the country.

Update: Our friend Francis Pileggi has an excellent post discussing the case, including treatment of its analysis of the exclusive forum clause.

I'm 61 years old. Do I really have to learn about Blockchain and AI?

My friend and occasional sparring partner Jeff Lipshaw discusses the disparity between the way academic lawyers and practitioners view blockchains and AI. 

It all sounds quite exhausting. I think I'll give it a pass.

Arnold & Porter's Guidance on the New California Law Requiring “Underrepresented Community” Members on Boards

Here. As with the similar gender representation bill from last year, I do not take a position on the merits or the equal protection constitutional validity of the law. As with the gender representation law, however, I think that as drafted it conflicts with the internal affairs doctrine and is thus unconstitutional under a penumbra emanating from the dormant commerce clause and the full faith and credit clause.

Dodge v. Ford Motor Co. and Shareholder Ratification

A friend sent along this question via email:

Would shareholder ratification/approval immunize the dividend policy in Dodge v. Ford (assuming Ford's votes don't count, and the Dodge brothers can't otherwise control the outcome)?  The reason I don't immediately say "yes" is because I wonder about the extent to which the dividend policy can be characterized as waste or bad faith -- thus potentially limiting the effect of SH approval/ratification.

If the facts of Dodge[1] came up today, my analysis would start with the premise that Henry Ford was the controlling shareholder of FMC. In Kahn v. M & F Worldwide Corp.,[2]  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. A vote by the majority of the minority shareholders, standing alone, thus is not enough to invoke the business judgment rule as the standard of review.

To be sure, Dodge involved a closely held corporation not a public company. But that is not a problem, because MFW has been applied to transactions involving  privately held companies.[3]

Likewise, Dodge did not involve a freezeout merger. Again, however, this is not a problem, because the expanded protections offered by MFW are not limited to freeze-out mergers, but have been extended to other types of controlling shareholder transactions. In Tornetta v. Musk,[4]  for example, the Delaware Chancery Court provided new guidance on how to structure conflict of interest transactions to which a corporation’s controlling shareholder is a party. The case involved a shareholder lawsuit challenging an incentive compensation plan granted to Tesla, Inc.’s CEO, Elon Musk.

Are we sure MFW applies?

Henry Ford might argue that MFW is inapplicable because he did not personally benefit from the transaction. Accordingly, he would argue, that the decision to cancel the special dividends  would not trigger entire fairness review. Because MFW is intended to shift the standard of review from entire fairness to the business judgment rule, it is inapplicable. This argument would find some support in the older Sinclair Oil v. Levien[5]decision. It held that controlling shareholders owe a fiduciary duty to the company’s minority shareholders. But what standard of review should a court apply to such disputes? The Delaware Supreme Court identified two standards potentially applicable in such situations: the business judgment rule and the intrinsic fairness rule. Under the business judgment rule, the directors of Sinven get the benefit of a rebuttable presumption of good faith. Under the intrinsic fairness test, the burden of proof is on the directors to show, subject to close scrutiny, that the transactions were objectively fair to Sinven.

Under Sinclair Oil, a court will apply the intrinsic fairness standard, as opposed to the business judgment rule, when the parent has received a benefit “to the exclusion and at the expense of the subsidiary.” In other words, the more exacting intrinsic fairness standard comes into play only when the parent is on both sides of the transaction and, moreover, used its position to extract non-pro rata benefits from a transaction to the minority shareholders’ detriment.

If the transaction is subject to business judgment rule review from the outset, shareholder ratification would eliminate any duty of care-based claims.[6]

Assume MFW is not limited to conflicted interest transactions

As I read the Tornetta opinion, there is a strong argument that MFW is not limited to conflicted interest transactions.

In his opinion, Vice Chancellor Joseph Slights acknowledged that Delaware courts normally approach boards’ executive compensation decisions with a high degree of deference. Critically, however, Musk is not just Tesla’s CEO but also its controlling shareholder.[7] A controlling shareholder has been analogized to the proverbial 800-pound gorilla,[8] which gives rise to “an obvious fear that even putatively independent directors may owe or feel a more-than-wholesome allegiance to the interests of the controller, rather than to the corporation and its public stockholders.”[9]

In Tornetta, the Tesla defendants argued that MFW was irrelevant to the facts of this case:

They rely heavily on a “statutory rubric” argument, claiming MFW’s dual protections, devised in the context of a squeeze-out merger, mimic the approvals required by 8 Del C. § 251 but have no practical application to transactions where our law does not mandate approval at both the board and stockholder levels. . . . I do agree with Defendants that nothing in MFW or its progeny would suggest the Supreme Court intended to extend the holding to other transactions involving controlling stockholders.

Vice Chancellor Slights, however, observed that the risk of coercion is just as present when a conflicted controller enters into a compensation arrangement as when it proposes a freezeout merger:

Indeed, in the CEO compensation context, the minority knows full well the CEO is staying with the company whether vel non his compensation plan is approved. As our Supreme Court observed in Tremont II:

[I]n a transaction such as the one considered . . . the controlling shareholder will continue to dominate the company regardless of the outcome of the transaction. The risk is thus created that those who pass upon the propriety of the transaction might perceive that disapproval may result in retaliation by the controlling shareholder.

These words apply with equal force to the compensation setting.

Accordingly, in order for a conflicted controller transaction to be reviewed under the business judgment rule rather than entire fairness, the transaction must satisfy all of MFW’s requirements.

Because the Tesla board had not satisfied all of those conditions, VC Slights invoked the older Kahn v. Lynch rule,[10] which explained that in controlling shareholder transactions:

The initial burden of establishing entire fairness rests upon the party who stands on both sides of the transaction. However, an approval of the 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.

Likewise, in Dodge, if the board did not comply with all of the MFW conditions, the burden would have shifted to the Dodge brothers to show that the transaction was unfair. Because “an entire fairness analysis is the only proper standard of judicial review,” however, shareholder ratification—absent full compliance with MFW would not invoke the business judgment rule.

Assume MFW applies and was fully complied with

If we assume that MFW applies and that FMC’s board complied fully with all six requirements. What happens next?

If they did, then a version of the business judgment rule applies under which the only remaining claim is one for waste. See In re Books-A-Million, Inc. S’holders Litig., 2016 WL 5874974, at *1 (Del. Ch. Oct. 10, 2016), aff’d, 164 A.3d 56 (Del. 2017) (TABLE). The waste exception is more theoretical than real, because to state a claim for waste, the terms of the transaction must be so extreme “that no rational person acting in good faith could have thought the [transaction] was fair to the minority.” In re MFW S’holders Litig. (MFW Chancery), 67 A.3d 496, 500 (Del. Ch. 2013), aff’d sub nom. MFW, 88 A.3d at 635. At that point in the analysis, two groups of rational people—the committee and the minority stockholders—would have approved the transaction. It is “logically difficult to conceptualize how a plaintiff can ultimately prove a waste or gift claim in the face of a decision by fully informed, uncoerced, independent stockholders to ratify the transaction.” Harbor Fin. P’rs v. Huizenga, 751 A.2d 879, 889 (Del. Ch. 1999). The resulting version of the business judgment rule is thus rightfully described as “irrebuttable.”[11]

I'm not sure how you would attack a decision to cancel a dividend as waste.

Video of the Zoom Conference Should Boards Have Duties to Stakeholders? Lessons from the COVID-19 Crisis

Delaware Chancery Court Holds Failure to Disclose "Intrinsic Value" Precludes Corwin Defense

A post from Tyler O'Connell of MorrisJames informs us that:

In In re USG Corp. S’holder Litig., 2020 WL 5126671 (Del. Ch. Aug. 31, 2020), the Court of Chancery granted the director-defendants’ motions to dismiss post-closing money damages claims arising out of the sale of USG Corporation (“USG”) for less than what USG’s directors allegedly thought was its intrinsic value. Although the failure to disclose such “intrinsic value” prevented dismissal under Corwin v. KKR Financial Holdings, LLC, 125 A.3d 304 (Del. 2015), Vice Chancellor Sam Glasscock III held that, in the circumstances, that omission and the directors’ approval of the sale did not suffice to plead a breach of the directors’ fiduciary duty of loyalty.  ...

The Court reasoned that, as recent Delaware appraisal cases have suggested, “intrinsic value” or “fair value” are “nebulous, even illusory, concepts.” With a “but see” cite to Delaware’s appraisal statute, the Court reasoned that “[b]elief in any particular intrinsic value, by any being less than an omniscient god, is necessarily a belief that is subjective in nature.” The Court held, however, that “because the Proxy Statement disclosed that the Board held a view of intrinsic value and frequently referenced such a view during its disclosures about the sales process, USG’s stockholders were entitled to know the Board’s opinion of USG’s intrinsic value, even if it was unachievable due to market forces and Knauf’s threats to launch a hostile takeover.” 

An asset (including a business) has no intrinsic value, of course. Instead, it is worth only what the buyer with the highest reservation price is willing to pay. The Delaware courts have recognized this. But the USG board apparently doesn't understand basic finance and they paid the price for being that dumb.