ProfessorBainbridge.com

New Article by Yours Truly: Long-Term Bias and Director Primacy

Long-Term Bias and Director Primacy (August 4, 2020). the Columbia Business Law Review (forthcoming), UCLA School of Law, Law-Econ Research Paper No. 20-04, Available at SSRN: https://ssrn.com/abstract=3666593

Abstract In an important recent contribution to the short-termism debate, Professors Michal Barzuza and Eric Talley what they call an “emerging consensus in certain legal, business, and scholarly communities … that corporate managers are pressured unduly into chasing short-term gains at the expense of superior long-term prospects. See Michal Barzuza & Eric L. Talley, Long-Term Bias (February 20, 2019), forthcoming in the Columbia Business Law Review, available at SSRN: https://ssrn.com/abstract=3338631. Instead, Barzuza and Talley contend that that “corporate managers often fall prey to long-term bias—excessive optimism about their own long-term projects.”

This article is an invited comment on Barzuza and Talley’s article. Subject to various quibbles raised herein, I broadly concur with Barzuza and Talley’s argument that corporate directors and officers can be biased towards long-term projects and, accordingly, may reject short-term projects offering higher returns.

But what law reforms follow logically from their conclusion, if any? With respect to judicial review, I want to differ with Barzuza and Talley on three points. First, I believe Barzuza and Talley overstate the risk of judicial intervention. Second, they fail adequately to distinguish between directors and managers, even though that distinction is central to the application of Delaware law. Third, I believe their analysis implies that judges should retain the deference to director decision making inherent in doctrines such as the business judgment rule and intermediate review.

With respect to encouraging shareholder activism, I argue that the responsibility for policing managerial hyperopia (or myopia, for that matter) should be assigned to the board of directors, not the shareholders. Heterogenous shareholders lack the proper incentives and knowledge to properly police management.

Keywords: corporate governance, management, directors and officers, short-term, long-term, behavioral economics

JEL Classification: K22

The Fourth Edition of Bainbridge on Corporate Law from Foundation Press' Concepts and Insights Treatise Series is Out

Many students find their Corporation Law class difficult because they do not understand the transactions giving rise to those cases. As with its predecessors, this fourth edition is intended to assist students by not only restating the law but also by putting the law into its business and financial context. The pedagogy is up-to-date, with a strong emphasis on the doctrinal issues taught in today's Corporations classes. The text is highly readable: The style is simple, direct, and reader-friendly. Even when dealing with complicated economic or financial issues, the text seeks to make those issues readily accessible.

This new edition brings the material up-to-date with complete coverage of developments in both state corporate law and federal securities law.

Law school faculty can view it here. Please consider recommending it to your Corporations and Business Associations students.

A Mini-Treatise on DGCL Section 220 Books and Records Inspections Inspired by Woods v. Sahara Enterprises, Inc.

Ar Francis Pileggi's invaluable corporate law blog, Frank Reynolds draws our attention to a new opinion by Delaware Vice Chancellor Travis Laster: Woods v. Sahara Enterprises, Inc. and links an earlier post on the same case from Mr. Pillegi himself.

Counselor Pileggi identifies the following takeaways from the case:

• A consequential aspect of this jewel of a decision is the instruction by the court that there is no basis in Delaware law to require a stockholder demanding corporate records under Section 220 to explain why the stockholder wants to value her interest in the company–in order to satisfy the recognized proper purpose of valuation. See Slip op. at 11; and 14-15.
• The court provided an extremely helpful list of many recognized “proper purposes” needed to be shown to satisfy Section 220. See Slip op. at 8-9.
• The court also recited several examples of what showing is recognized as sufficient to satisfy the “credible basis requirement” to investigate mismanagement pursuant to Section 220. See Slip op. 18-19.
• An always useful recitation of the basic elements of the fiduciary duty of directors of a Delaware corporation and the subsidiary components of the duty of loyalty and care, are also featured. See Slip op. at 20.
• The court categorized the specific requests for documents in this case as follows: (i) formal board materials; (ii) informal board materials; and (iii) officer-level materials. Then the court expounds on the different focus applicable to each category.
• Notably, after quoting the actual document requests, the court found that some of them were overly broad–but the court edited and narrowed some of the requests before concluding that the company was required to produce the court-narrowed scope of documents.

Reynolds summarizes key parts of the court's opinion as follows:

The Vice Chancellor said one of Wood’s purposes is to value her shares and, “valuation of a stockholder’s investment in a corporation, particularly where the corporation is privately held, has long been recognized as a proper purpose under 8 Del. C. § 220.”

He rejected Sahara’s argument that Woods failed to show she actually had a proper purpose and “the mere incantation of an accepted ‘valuation’ purpose in a private corporation is [not] sufficient.”  That position is “contrary to Delaware law,” because it “would require that a stockholder establish both a proper purpose (valuing shares) and an end use for the resulting valuation,” the court said.

Woods also established a reason to investigate wrongdoing, and “inspecting the company’s books and records can help the stockholder to ferret out whether that wrongdoing is real and then possibly file a lawsuit if appropriate,” Vice Chancellor Laster ruled.

Although the company’s poor performance, without more, has not been sufficiently protracted or extreme to draw an inference of wrongdoing, the tactical position that Sahara took during the litigation points to conflicts that might bolster Wood’s case, he said. ...

Regarding which documents must be produced for each category’s stated purpose, he said they must be “essential and sufficient to [its] stated purpose.”

How directors and senior officers are compensated and whether they are the beneficiaries of any related-party transactions are basic facts that stockholders are entitled to know and investors are entitled to know how their fiduciaries are taking money out of the corporation, the Court said. “A stockholder should not have to point to a valuation purpose or assert suspicions about corporate wrongdoing to be able to learn how much money the directors and senior officers are receiving.”

In addition, the vice chancellor said Sahara’s annual reports did not make clear who the various officers and directors listed worked for and investors are entitled to know (i) who the Sahara senior officers are, (ii) how much compensation they receive, and (iii) whether Sahara has entered into related party transactions with any officers or directors.

“The Trust’s desire to know this information is itself a proper purpose,” and the Trust is entitled to a court order for the production of any documents from the allied companies that their controllers could “access in the normal course of business,” he said.

All of which got me to thinking about Section 220.

A shareholder must have a proper purpose for requesting a 220 inspection.  If the Company denies the shareholder access to its records, the shareholder may sue in the Chancery Court. Under subsection 220(c), if the shareholder only seeks access to the shareholder list or stock ledger, the burden of proof is on the Company to show that the shareholder is doing so for an improper reason. If the shareholder seeks access to other corporate records, however, the shareholder must prove that s/he is doing so for the requisite proper purpose.

“The paramount factor in determining whether a stockholder is entitled to inspection of corporate books and records is the propriety of the stockholder’s purpose in seeking such inspection.”  CM & M Gp., Inc. v. Carroll, 453 A.2d 788, 792 (Del. 1982). “A proper purpose shall mean a purpose reasonably related to such person’s interest as a stockholder.” DGCL § 220(b) (emphasis supplied).

As Pileggi notes, Vice Chancellor Travis Laster’s new Woods opinion summarizes the proper purposes recognized by Delaware courts:

Prior cases have recognized that a stockholder can state a proper purpose by seeking

• to investigate allegedly improper transactions or mismanagement;
• to clarify an unexplained discrepancy in the corporation’s financial statements regarding assets;
• to investigate the possibility of an improper transfer of assets out of the corporation;
• to ascertain the value of his stock;
• to aid litigation he has instituted and to contact other stockholders regarding litigation and invite their association with him in the case;
• “[t]o inform fellow shareholders of one’s view concerning the wisdom or fairness, from the point of view of the shareholders, of a proposed recapitalization and to encourage fellow shareholders to seek appraisal”;
• “to discuss corporate finances and management’s inadequacies, and then, depending on the responses, determine stockholder sentiment for either a change in management or a sale pursuant to a tender offer”;
• to inquire into the independence, good faith, and due care of a special committee formed to consider a demand to institute derivative litigation;
• to communicate with other stockholders regarding a tender offer;
• to communicate with other stockholders in order to effectuate changes in management policies;
• to investigate the stockholder’s possible entitlement to oversubscription privileges in connection with a rights offering;
• to determine an individual’s suitability to serve as a director;
• to obtain names and addresses of stockholders for a contemplated proxy solicitation; or
• to obtain particularized facts needed to adequately allege demand futility after the corporation has admitted engaging in backdating stock options.

Woods v. Sahara Enterprises, Inc., 2020 WL 4200131, at *4-5 (Del. Ch. July 22, 2020).

Delaware courts have made clear that the existence of an improper secondary purpose is not enough to deny the shareholder access. Because “a shareholder will often have more than one purpose, [§ 220(b)] has been construed to mean that the shareholder’s primary purpose must be proper; any secondary purpose, whether proper or not, is irrelevant.” BBC Acquisition v. Durr-Fillauer Medical, 623 A.2d 85, 88 (Del.Ch.1992). This invites litigation as to what the shareholder’s primary purpose is and then whether it is proper.

Even if the shareholder manages to convince the court that his primary interest is, say, valuing shares, if the Company is able to show the shareholder also has an improper secondary purpose, the court may circumscribe the shareholder’s access so as to protect legitimate corporate proprietary interests. Safecard Servs., Inc. v. Credit Card Serv. Corp., 1984 WL 8265 (Del.Ch.1984).

A new hurdle is suggested by Travis’ new opinion in Woods. In it, he draws a sharp distinction between three distinct levels of corporate books are records:

• Formal Board Materials: “The starting point (and often the ending point) for an adequate inspection will be board-level documents that formally evidence the directors’ deliberations and decisions and comprise the materials that the directors formally received and considered (the “Formal Board Materials”). A corporation should be able to collect and provide its Formal Board Materials promptly and with minimal burden. In many organizations, the corporate secretary maintains a central file for each board meeting in either paper or electronic form that contains the minutes and other Formal Board Materials for that meeting.” Woods, 2020 WL 4200131, at *11.
• Informal Board Materials: “If the plaintiff makes a proper showing, an inspection may extend to informal materials that evidence the directors’ deliberations, the information that they received, and the decisions they reached (“Informal Board Materials”). Informal Board Materials generally will include communications between directors and the corporation’s officers and senior employees, such as information distributed to the directors outside of formal channels, in between formal meetings, or in connection with other types of board gatherings. Informal Board Materials also may include emails and other types of communication sent among the directors themselves, even if the directors used non-corporate accounts.” Id. at *12.
• Officer-Level Materials: “In an appropriate case, an inspection may extend further to encompass communications and materials that were only shared among or reviewed by officers and employees (“Officer-Level Materials”).” Id.

Personally, I think that hierarchy is the most important takeaway in the opinion. This is so, because Laster goes on to suggest that there is a clear hierarchy here. Woods is repeatedly given access to Formal Board Materials without much of a showing. A stronger showing is required for Informal Board Materials and Officer Level Materials:

Request (j) seeks “[d]ocuments, correspondence, reports or drafts thereof concerning any investment decision, business plan, valuation, budget, financial guidance, forecast or projections concerning the Company from January 1, 2015 to present.” JX 2 at ’199. The request does not distinguish among Formal Board Materials, Informal Board Materials, or Officer-Level Materials. The detailed nature of the request suggests that it seeks all three.

As framed, request (j) is overly broad. In the abstract, “[t]he importance of forecasts and projections to valuation of a company is so basic that it does not require citation.” Quantum Tech., 2014 WL 2156622, at *12 (Del. Ch. May 14, 2014). Woods is therefore entitled to inspect Formal Board Materials falling into this category. Woods has not proven that Informal Board Materials or Officer-Level Materials concerning financial guidance, forecasts, or projections are necessary and essential to her valuation purpose, and thus she is not entitled to those materials. If she receives Formal Board Materials and determines that they are inadequate for her purpose, then she may renew her request for Informal Board Materials and Officer-Level Materials.

Id. at *13. Earlier Delaware cases established that a Section 220 proceeding should result in an order "circumscribed with rifled precision.” Security First Corp. v. U.S. Die Casting and Development Co., 687 A.2d 563 (Del.1997).  Accordingly, the court of chancery must tailor its order for inspection to cover only those books and records that are “essential and sufficient to the stockholder’s stated purpose.” Thomas & Betts Corp. v. Leviton Mfg. Co., 681 A.2d 1026, 1035 (Del. 1996). The shareholder “bears the burden of proving that each category of books and records [being sought] is essential to accomplishment of the stockholder’s articulated purpose for the inspection.” Id.

Laster’s Woods opinion does not include the “rifled precision” quote but does draw on both Thomas & Bettsand Security First in setting the scope of the inspection to which Woods is entitled. Again, he principally tailors that access by focusing on the hierarchy between the various defined levels of materials:

According to Woods, requests (c), (d), (e), and (h) seek information about the Company’s investment strategies. Requests (c), (d), and (e) are actually much broader. They seek

(c) All minutes of meetings of the Company’s Board of Directors (the “Board”) or any committee thereof, including any attachments thereto, from January 1, 2015 to present;

(d) All presentations, agendas, reports or other materials provided to the Board or any committee thereof in preparation for, or review at, any meetings from January 1, 2015 to present; [and]

(e) All notes taken at any meetings of the Board or any committee thereof from January 1, 2015 to present.

JX 2 at ’198–99. These requests thus seek all of the Company’s Formal Board Materials from January 1, 2015, to the present, plus Informal Board Materials in the form of notes.

Request (h) seeks a subset of the foregoing materials. It asks for

[a]ll materials created for or provided to the Board or any committee thereof from January 1, 2015 to present concerning the Company’s investment strategies, any actual or proposed changes to the mix or types of investments made by the Company; returns from any investments; liquidity considerations; or tax consequences of investments for the Company or its stockholders.

Id. at ’199. Request (h) thus seeks Formal Board Materials relating to the Company’s investment strategies, investment holdings, and related issues.

The blanket request to inspect all of a Company’s Formal Board Materials, plus notes of all meetings, is not sufficiently targeted. Request (h) specifically requests Formal Board Materials concerning the Company’s investment strategy and investments, which is a core area of focus for the Demand. Books and records responsive to this request appear sufficient for Woods’ purpose. The Company shall produce materials responsive to Request (h). As to matters falling within the scope of Request (h), the Company shall produce the types of materials called for by Requests (c), (d), and (e). The Company need not produce materials that otherwise would be called for by Requests (c), (d), and (e), but which do not relate to the topics covered in Request (h).

Woods, 2020 WL 4200131, at *11.

All of which suggests that getting at the really interesting stuff—i.e., Informal Board Materials and Officer Level Materials—is going to be tough.

California's Racial/Ethnic Quota Bill Is Amended To Expand Definition Of "Underrepresented Communities"

Keith Paul Bishop has the details.

Dorothy Lund's Passive Investing and Corporate Governance: A Law and Economics Analysis

I love literature reviews and wish more legal academics did them. Dorothy Lund's new chapter on passive investing for the Encyclopedia of Law and Economics is an excellent example of how a critical review of the literature can strengthen our understanding of a field.

Abstract: An important debate in corporate governance is whether passive funds — a term that includes ETFs and index funds — have incentives to provide adequate oversight of their portfolio companies. One set of scholars contends that agency cost problems likely thwart passive fund stewardship for several reasons. First, passive funds suffer from an acute collective action problem because any investment in improving the performance of a company will benefit all funds that track the index equally, while only the activist fund will incur the costs. Indeed, these scholars point out that investments in stewardship are particularly costly for the passive fund portfolio manager, which lacks the firm-specific information necessary to participate in governance in a beneficial way. Second, passive fund portfolio managers may have inadequate incentives to invest in beneficial stewardship because they capture only a small fraction of the gains. And third and finally, passive fund portfolio managers have ample incentive to be excessively deferential to management, who are often their clients. These scholars conclude that because of these flawed incentives, the rise of passive investing portends economic harm and justifies wide-ranging regulatory intervention — from incentivizing passive fund stewardship, to restricting passive fund voting rights. Another set of scholars contend that passive fund stewardship is likely to be as good as, if not better than, stewardship by other investors. They contend that passive funds compete for investor dollars not just against other passive funds, but also against actively managed mutual funds. This competition provides an incentive for passive funds to invest in stewardship that will attract asset inflows. In addition, the large size of the institutional investors that offer passive funds affords them economies of scale and scope in stewardship. And because these large institutional investors have massive stakes in portfolio companies, capturing even a small fraction of any gain will substantially increase their take home pay, providing an incentive to be engaged for a small number of material votes that occur each year. These scholars contend — in the words of Adam Smith, and later, Jack Bogle — that the invisible hand is all that is needed. This is a chapter from the forthcoming Encyclopedia of Law and Economics (Adam Badawi, ed., 2nd edition 2020).

Keywords: Mutual Funds, Passive Funds, ETFs, Index Funds, Corporate Governance, Law and Economics, Corporate Law

JEL Classification: K22, K20, K2

Lund, Dorothy S., Passive Investing and Corporate Governance: A Law and Economics Analysis (June 9, 2020). Available at SSRN: https://ssrn.com/abstract=3623381 or http://dx.doi.org/10.2139/ssrn.3623381

Making Sense of The Business Roundtable’s Reversal on Corporate Purpose

Bainbridge, Stephen Mark, Making Sense of The Business Roundtable’s Reversal on Corporate Purpose (July 30, 2020). UCLA School of Law, Law-Econ Research Paper No. 20-03, Available at SSRN: https://ssrn.com/abstract=3664078

Abstract: In August 2019, the Business Roundtable (BRT) issued a statement on the purpose of the corporation in which it reversed a longstanding position. Since 1978, the BRT has periodically issued statements on Principles of Corporate Governance, which purport to summarize law and best practice in this area. Since 1997, all versions of those statements had embraced the view that corporations exist primarily to serve their shareholders. In contrast, the 2019 version contains a much broader conception of corporate purpose, which posits that corporations should “commit to deliver[ing] value to all of” the corporation’s stakeholders.

Obviously, the BRT cannot unilaterally change the law. As this article explains, the law of corporate purpose remains that directors have an obligation to put shareholder interests ahead of those of other stakeholders and maximize profits for those shareholders.

What people do matters more than what they say. To date, the evidence is most BRT members remain committed to shareholder value maximization, despite their recent rhetoric to the contrary. This should not be surprising. The incentive structure faced by directors and managers still skews in favor of shareholders.

Why then did the BRT shift position? This article suggests two possibilities. First, the members may be engaged in puffery intended to attract certain stakeholders for the long-term benefit of the shareholders. Specifically, they may be looking to lower the company’s cost of labor by responding to perceived shifts in labor, lower the cost of capital by attracting certain investors, and increase sales by responding to perceived shifts in consumer market sentiment. They may also be trying to fend off regulation by progressive politicians. Second, some BRT members may crave a return to the days of imperial CEOS.

This article is a response to Jeffrey M. Lipshaw, The False Dichotomy of Corporate Governance Platitudes, Journal of Corporation Law (forthcoming).

Keywords: corporate law, corporate social responsibility, ESG, board of directors, corporate purpose

JEL Classification: K22, M14

A brilliant flow chart of Delaware corporate law standards of review

I wish I had done this, but I am glad to have found the brilliant flowchart by 3 Troutman lawyers accurately summarizing Delaware law standards of review.

H/T: Keith Paul Bishop

Padfield on Lipshaw on Corporate Purpose

Stefan Padfield writes:

Jeffrey Lipshaw has posted "The False Dichotomy of Corporate Governance Platitudes" on SSRN.  I have set forth the abstract below.  I had the pleasure of reading an early draft, and I highly recommend the paper.  Among other things, Jeff brings a level of practical experience to the topic ("more than a quarter century as a real world corporate lawyer and senior officer of a public corporation") that makes his views a must-read.  Having said that, my own view is that the “shareholder vs. stakeholder” debate is meaningful even if it only really matters in "idiosyncratic cases in which corporate leaders have managed to be either bullheaded or ill-advised."

In 2019, the Business Roundtable amended its principles of corporate governance, deleting references to the primary purpose of the corporation being to serve the shareholders. In doing so, it renewed the “shareholder vs. stakeholder” debate among academic theorists and politicians. The thesis here is that the zero-sum positions of the contending positions are a false dichotomy, failing to capture the complexity of the corporate management game as it is actually played. Sweeping and absolutist statements of the primary purpose of the corporation are based on arid thought experiments and idiosyncratic cases in which corporate leaders have managed to be either bullheaded or ill-advised. In the real world, management regularly commits itself to multiple competing constituencies, including the shareholders.

There are three arguments. The first is from reality, borne out by a survey of pre-amendment CEO annual report letters to shareholders (2017) and post-amendment responses (2020) to the COVID-19 pandemic. The second is from economics. Neo-classical economic theory supporting the doctrine is misplaced; transaction cost analysis under the New Institution Economics does a far better job of explaining the primacy of wide corporate discretion in allocating surplus among the corporate constituencies. The third is from jurisprudence. Doctrinal dicta like “corporations exist primary to maximize shareholder wealth” are not so much right or wrong as meaningless. Rather, the business judgment rule, which justifies almost any allocation of corporate surplus having an articulable connection to the best interest of the enterprise, subsumes all other platitudes posing as rules of law.

Watch this space for a related announcement coming soon.

Padfield on Politics and Corporate Governance

Stefan Padfield: The Specter of Political Bias Is Haunting Corporate Governancehttps://t.co/LcWLKkQnl2

— Professor Stephen Bainbridge (@PrawfBainbridge) July 22, 2020

Qualcomm latest company to be hit with shareholder derivative suit alleging various diversity-related board breaches of duty

I mentioned the other day that there appears to be an emerging trend of plaintiff lawsuits alleging that boards of directors have committed various breaches of fiduciary duty and/or disclosure obligations in connection with their companies' diversity or lack thereof.

The invaluable Kevin LaCroix brings word of yet another suit, this time targeting Qualcomm:

... a Qualcomm shareholder has filed a derivative lawsuit against the company’s board, alleging that the company’s directors violated their duties to the company and shareholders by falling short of stated objectives on diversity and inclusion and by falling to include a single African-American either on the board or among the company’s senior officers. The lawsuit against Qualcomm follows similar lawsuit filed earlier this month against Oracle and Facebook. A copy of the July 17, 2020 complaint against the Qualcomm board can be found here.

The complaint alleges that despite the company’s various public statements about the importance of diversity and inclusion, the company’s board includes no African-Americans (though it does include three women), and there are no African-Americans among the company’s top executives. Even the company’s Chief Diversity Officer is white. The company’s workforce is only 1.5% African American and the company has made no progress in increasing the number of African American employees since 2017. The problem, the complaint alleges, is that not just been lack of diversity but also discrimination against African Americans. ...

Like the complaints previously filed against Oracle and Facebook, this new complaint against Qualcomm is not directly tied to the current racial justice protests. There is no mention in the complaint to the Black Lives Matter movement. There is no reference to the complaint to the death of George Floyd or of the demonstrations and civil unrest that followed his death. However, the three complaint undeniably are linked to the current racial justice movement and are obviously being filed now because of the heightened visibility of racial diversity and inclusion issues as a result of the protests and demonstrations.

I am unaware of any cases determining whether either state law fiduciary duty claims or the federal disclosure claims of the sort brought here have merit. In any case, this is a very interesting development that bears watching.

Francis Pileggi's Mid-2020 Review of Key Delaware Business Law Decisions

Francis Pileggi's annual survey of important Delaware business law decisions is an invaluable way for keeping track of developments in Delaware corporate law (also contract and commercial law, if they are of interest). Occasionally, when there have been a lot of big decisions, he does a mid-year post. This year he offers up a mid-year report by Jeff Montgomery of Law360.

Here's the link.

You'll particularly want to check out his discussion of:

• Matthew B. Salzburg et al. v. Matthew Sciabacucchi, the key federal forum selection provision case
• Dell Technologies Inc. Class V Stockholders Litigation, which lays out "a sort of Field Guide to Corporate Breaches"
• In re: Tesla Motors Inc. Stockholder Litigation, in which the challenge to the Tesla-Solar City merger continues

2020 Amendments to the Delaware General Corporation Law

RLF offers a blog post summarizing the extensive 2020 amendments. The text of the bill as signed by the governor is here. The bill amends a number of important provisions:

• Improves the provisions governing emergency bylaws (useful in the coronavirus crisis era) by:
  • Clarifying when such emergency bylaws may be invoked.
  • Creating safe harbors for certain corporate actions taken during the emergency.
• Makes it easier for a conventional corporation to become a public benefit corporation (and vice versa). This provision is somewhat concerning in light of our discussion the other day of the problems PBCs have in making a credible commitment to their beneficial purpose.
• Clarifies the safe harbors for documents executed electronically.
• Clarifies which corporate officers are protected by the indemnification provision of section 145(c).

Skadden has a useful summary of the changes here.

Cydney Posner explores whether the changes to the PBC provisions will lead to a greater number of PBC IPOs.

These changes will be incorporated into the 2021 edition of the Klein, Ramseyer & Bainbridge Business Associations statutory supplement.

Delaware courts define materiality for purposes of state law claims and illustrate why I'm skeptical of juries

From JDSupra:

City of Fort Myers General § Employees’ Pension Fund v Haley, which was commenced in the Delaware Court of Chancery, grew out of the merger of equals between Towers Watson & Co. and Willis Group Holdings Public Limited Company. ...

ValueAct Capital Management, L.P., an institutional stockholder of Willis, through its Chief Investment Officer, Jeffrey Ubben, presented to John J. Haley, the Chief Executive Officer and Chairman of Towers who was spearheading the merger negotiations, a compensation proposal with the post-merger company that would potentially provide Haley with a five-fold increase in compensation. Haley did not disclose this proposal to the Towers Board.

From the Morris James blog:

A plaintiff challenging a merger when a majority of the board approving the transaction is disinterested and independent and there is no controlling stockholder on both sides cannot state a cognizable claim of breach of fiduciary duty unless it can plead facts demonstrating that the business judgment rule does not apply. 

One way to plead around the business judgment rule is to assert that a merger partner offered material compensation to the opposing party’s lead negotiator in the midst of uncertain merger negotiations to incentivize him to do as little as possible to improve the merger consideration for his stockholders. That allegation would have to be coupled with a claim that the compensation was subjectively material to the lead negotiator and that he failed to disclose it to the full board. ...

The Court defined “materiality” as “relevant and of a magnitude to be important to directors in carrying out their fiduciary duty of care in decision-making.”

It is interesting to compare that definition of materiality to the one in the federal securities laws, which requires a showing that there is a substantial likelihood that the reasonable investor would consider the information to be important in deciding how to vote (or to enter into a transaction or whatever). As the Haley court explained (at 31):

Although we need not look to the stockholder disclosure cases, we pause to address the parties’ competing assertions about the relevance of those cases. In Brehm v. Eisner, we noted that the term “material,” when used in the context of a director’s obligation to be candid with the other members of the Board, “is distinct from the use of the term ‘material’ in the quite different context of disclosure to stockholders in which ‘[a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider itimportant in deciding how to vote.’”⁶¹ ...

In this case, although the materiality inquiry is different in the two contexts, we conclude that the allegedly omitted information would be material in either context.

⁶¹ Brehm, 746 A.2d at 259 n.49. Delaware has adopted the federal standard for materiality in the shareholder disclosure context. See Morrison v. Berry, 191 A.3d 268, 282 (Del. 2018) (“An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote.”) (quoting Rosenblatt v. Getty Oil Co., 493 A.2d 929, 944 (Del. 1985) (quoting TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976))). We reject any contention in the briefing that the Delaware standard differs from the federal standard in this context.

It has never been clear to me why the materiality standard should differ in these two contexts. The opinions I've read in which the issue has come up tend to state that the two are different, but do not explain why.

BTW, here's an interesting tidbit from the Morris James post:

The fact that a dissenting Justice found that the disclosure of the Proposal was not material in light of the Towers Board’s knowledge that post-merger, Haley would be the CEO of the combined, larger entity, underscores that these judgements are not always clear-cut.

The fact that experienced jurists and lawyers who sit on the top corporate law court in the country disagreed as to the materiality of the information illustrates once again the risibility of asking lay jurors to decide whether information is material. Craziness.

The Derivative Suit Against Facebook Alleges Various Race-related Actions and Inactions = Breach of Fiduciary Duty

Kevin LaCroix has a typically detailed and thoughtful analysis of the suit:

In a recent post (here), I discussed the shareholder derivative suit filed against the board of directors of Oracle Corporation based on the alleged lack of racial diversity on the company’s board. Turns out that in addition to the lawsuit against Oracle’s board, the law firms that filed the Oracle lawsuit also have  filed a shareholder derivative lawsuit against Facebook’s board alleging that the directors had violated their fiduciary duties by their inaction on diversity and inclusion issues; their tolerance of racially discriminatory practices both in its workforce and on its platform; and their failure to take action on hate speech on its platform. Along with the Oracle lawsuit, the new lawsuit against Facebook provides another example of how the current heightened focus on diversity and inclusion issues can translate into D&O claims. A copy of the complaint in the Facebook action can be found here.

I am reminded of the old aphorism: once is happenstance, two is a coincidence, but three is a trend. The lawyers behind these suits clearly think they have a winning formula.

The likelihood is that there will be further claims like this to come. Indeed, one of the lawyers responsible for filing both the Oracle and Facebook lawsuits, Frank Bottini of the Bottini and Bottini law firm, is paraphrased in a July 8, 2020 Law.com article about the two lawsuits (here) as saying that he “plans to bring more shareholder derivative lawsuits against Silicon Valley companies who allegedly do not follow through on their diversity initiative.” ...

Of course, it remains to be seen whether other companies will be sued on similar theories as those raised in these lawsuits or how far the litigation phenomenon might spread. At this point, with only two lawsuits filed, it would be premature to suggest that these diversity and inclusion lawsuits represents an important D&O litigation trend and that the possibility of these kinds of lawsuit represents a significant potential board litigation exposure. Just the same, the filing of these two lawsuits and the possibility for more does suggest that this type of litigation could be an important emerging trend and one that is worth watching.

Even if it's not a viable claim, it may be a lawsuit the companies will want to settle to make them go away. Also, as LaCroix points out, litigation can be part of an overall package of activist tactics:

In the current focus on social and racial issues, activists will use a number of means, including claims against corporate boards, to try to advance their diversity and inclusion goals. ...

Among the things these companies will have to consider is whether to make concessions and adopt measures the plaintiffs in the respective cases have proposed, in order to try to deflect the attention and adverse publicity these kinds of cases might produce in the current environment.

The front matter for my new Advanced Corporation Law casebook: Table of content, table of cases, preface, Chapter 1

After I announced that my new Advanced Corporation Law casebook was in galleys, Tennessee law professor Joan Heminway (@VolunteerTwit) kindly suggested I post the front matter--table of contents, preface, table of cases, etc...

Glad to do it. I also included Chapter 1 as a sample. Download the front matter here.

Comments welcome; indeed, encouraged.