Lucian Bebchuk is the James Barr Ames Professor of Law, Economics, and Finance and Director of the Program on Corporate Governance at Harvard Law School. This post is part of the Controlling Shareholder Series; links to other posts in the series are available here.
In a recent study, Controllers Unbound, Kobi Kastiel and I explain how the relaxation of control constraints following the adoption of SB21 should be expected to have substantial adverse effects on public investors and controlled companies. Among the risks that we identified were those resulting from enabling controllers to pursue recapitalizations using nonvoting shares to retain a lock on control while cashing out a substantial fraction of the controller’s equity stake. The recent Cloudflare decision (discussed in the Forum here) focused on such a recapitalization. Although the decision allowed the dismiss shareholder suit challenging the recapitalization to proceed to trial, it nonetheless validates and reinforces the concerns we raised in Controllers Unbound.
Delaware’s recent SB21 legislation provided controllers with a safe harbor for conflicted transactions (other than freezeouts) that satisfy certain process requirements. Under SB21 cleansing such transactions generally would not require approval by public investors; controllers would just need to obtain approval from two independent directors that are willing to go along. As a result, our study explained, post-SB21, controllers would have an array of ways to benefit themselves considerably at the expense of public investors – including by control-perpetuating recapitalizations, elimination of long-standing sunsets, large related-party transactions, extraction of mega-pay packages, and so forth and so on.
Some observers have nevertheless retained hope after the adoption of SB21 that Delaware courts would in many cases find ways to protect public investors from being harmed by conflicted transactions. Cloudflare should greatly curtail any such hopes.
In Cloudflare, the shareholder suit sought to use some language in SB21 to argue that SB21’s safe harbor does not cover conflicted transactions that are control-enhancing. The case was assigned to Vice Chancellor Travis Laster, who in pre-SB21 days contributed to a line of cases that SB21 reversed. However, Laster concluded that SB21 compelled him to reject the claimed exception to the statute.
