Monthly Archives: April 2008

Delaware Court Upholds Bylaw Amendment that Cuts Off Advancement Rights to Former Directors

This post is from Steven M. Haas of Hunton & Williams LLP. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

On March 28, the Delaware Court of Chancery issued a decision in Schoon v. Troy Corporation, upholding a board-approved bylaw amendment that cut-off advancement rights to a former director. I previously posted here on related litigation between the parties where the court held that directors do not have standing to bring derivative suits.

At issue this time was an amendment to the company’s advancement bylaw, which originally provided that “the Corporation shall pay the expenses incurred by any present or former director.” After a director left the board but shortly before he became involved in litigation with the company, the existing board amended the bylaw to delete the reference to “former” directors.

Once litigation began, the director claimed a vested right to mandatory advancement because the lawsuit related to his official capacity as a former director when the original bylaw was in place. As a result, the bylaw amendment arguably had no affect on his advancement rights. He relied on a prior Delaware decision, Salaman v. National Media Corp., 1992 WL 808095 (Del. Super. Oct. 8, 1992), holding that a board of directors cannot unilaterally terminate a former director’s right to advancement through a bylaw amendment while litigation is pending.

The Court of Chancery rejected the former director’s argument and upheld the bylaw amendment that denied him mandatory advancements. It reasoned that a director’s right to advancement becomes “vested” when litigation is filed, not when the underlying conduct allegedly occurred. This holding may surprise some practitioners, given that the purpose of indemnification and advancement is to encourage board service and assure directors that their expenses relating to their official actions will be paid—even if litigation arises after they resign from the board. In addition, this holding was in spite of another bylaw provision providing that “[t]he rights conferred by this Article shall continue as to a person who has ceased to be a director or officer and shall inure to the benefit of such person.” The court explained that this provision “is better understood as providing that a director, whose right to advancement is triggered while in office, does not lose that right by ceasing to serve as a director” (emphasis added).

Decisions affecting directors’ rights to advancement and indemnification are always significant. This decision, in particular, may have important implications for dissident directors and directors who are ousted in proxy contests. Both litigators and drafters should take note.

The opinion is available here.

The Role of the States – Foreign and Domestic

The General Counsel of the Securities and Exchange Commission and Harvard Law School graduate, Brian G. Cartwright, recently gave the Distinguished Scholar Address at Widener University School of Law. Entitled The Role of the States (Foreign and Domestic), the speech addressed the question of what the increasingly global nature of securities markets and business will mean for Delaware general corporation law. After reflecting on changes in securities investing and commerce in recent decades, Mr. Cartwright envisioned a world in which “a global stockholder base trades the stock of transnational companies in just a few market centers with a global reach.” As greater parts of the world embraced the benefits of free-market capitalism, he predicted, the U.S. might lose the commanding dominance it once enjoyed, although it would likely remain one of the world’s leading capital markets. Mr. Cartwright likened competition for corporate charters in the U.S. to the situation now prevailing in Europe, and questioned how state competition for corporate charters would play out at the international level.

The speech is available here.

AFL-CIO Proxy Voting: A Response by Agrawal

The Agrawal study is described on our blog here; the initial AFL-CIO response is available on our blog here; two reactions to that AFL-CIO response – from Ashwini Agrawal and from Steven Kaplan – are available here; the subsequent AFL-CIO response is available here.

I am writing to respond to the recent post by Daniel Pedrotty, director of the AFL-CIO Office of Investment, critiquing my study on AFL-CIO proxy voting.

First, in contrast to Pedrotty’s claim that I was never in contact with the AFL-CIO Office of Investment, I contacted Michele Evans, office administrator of the AFL-CIO Office of Investment by email on May 22, 2007, and received a reply from her by email on June 1, 2007. The email exchange is available here.

Second, I would like to respond to Pedrotty’s request that I share my data with the AFL-CIO on a confidential basis with the AFL-CIO committing not to share it with any rival researcher and to use it solely to “check the accuracy” of my findings. Given that the AFL-CIO has not provided me data and information when I have requested it and has made what I consider false and misleading statements about my research, I have serious concerns, as do my advisors, that the AFL-CIO will misuse and mischaracterize any data I send them prior to publication. I therefore will not enter into the requested confidentiality agreement with them. Instead, I suggest they consult the public sources of data I use in writing my paper and replicate the findings themselves.

Third, I would like to respond to Pedrotty’s claim that the study is not possible to replicate using public information. Pedrotty makes a useful point that I did not fully describe the information I obtained from Investor Relations departments, however, as I will make clear in the next version of the paper, the findings in the paper are the same if one relies on the public data sources described in the paper. The next draft will explain that I contacted four companies whose investor relations departments confirmed, consistent with the lack of discussion of unionized workers in their 10-K’s, that they did not have union workers (an assumption I discuss in the paper). I will also make sure to fully describe any information I get from additional investor relations departments or other sources that I may choose to contact while revising my study.

As for other claims raised by Pedrotty, I have addressed them already in my earlier post, available here.

Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling

This post is from Mark Ramseyer of Harvard Law School.

The Program on Corporate Governance has recently issued as a discussion paper my piece, entitled Ringling Bros.-Barnum & Bailey Combined Shows v. Ringling: Bad Appointments and Empty-Core Cycling at the Circus.

On the surface, the Ringling case appears to be an irrational spat over board seats by the heirs of a very successful enterprise. However, a closer inspection reveals that the investors were neither fighting over board seats nor were they irrational. Although Edith Ringling pushed her incompetent son and Aubrey Haley her inappropriate husband, they did so to their private advantage. Although the circus cycled from one management team to another, the investors always promoted the new teams for private gain.

I argue that the root of the Ringling dispute lay in the inability of the law to enforce duty-of-loyalty standards. When the law works as it should, fiduciary duties perform two functions: they remove the incentive to appoint corporate officials by kinship rather than ability, and prevent the empty core cycling that would otherwise plague so many close corporations. Here it performed neither. In the Ringling case, I argue that the various parties had incentives to defect in the next period regardless of the alliances they formed in the current period. When the law does not enforce a duty of loyalty, this allows cycling to occur. If the law gave each investor a return proportional to his or her interest in the firm, investor alliances would not cycle. Not only will investors not appoint inept kin, management will not cycle from alliance to alliance. The Ringling circus did not degenerate into the chaos in which it found itself because the investors were spoiled or irrational. It degenerated because the law could not enforce the duty of loyalty.

The full paper is available for download here.

TravelCenters of America LLC v. Brog

This post is from Rodman Ward of Skadden, Arps, Slate, Meagher & Flom LLP. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Chancellor Chandler in litigation captioned TravelCenters of America LLC v. Brog, et al., C.A. No. 3516-CC decided, among other issues, two significant legal questions worthy of broader publication. Since both rulings are contained in memorandum opinions, they will not be reported officially. The first ruling was contained in a pre-trial memorandum opinion and dealt with the admissibility of a law professor’s expert testimony on matters of state and federal law. The second, contained in a bench memorandum delivered at the end of the trial, decided whether provisions contained in an LLC Agreement were required to comport with concepts of “good corporate governance.”

I. Law Professor Testimony
In the pre-trial ruling, the Chancellor held that expert testimony from a law professor (a) could not be presented on the question as to whether, under Delaware law, the LLC’s provisions regarding advance notice were consistent with good corporate governance practices but (b) could be presented as to whether the Notice complied with the Agreement’s incorporation of federal securities law disclosure. The first holding was based on an unreported opinion in the Court’s earlier Disney litigation which had held that “‘in this Court, witnesses do not opine on Delaware corporate law.” The pre-trial ruling foreshadowed the result of the case in chief by stating that: “Delaware does not impose a legal requirement on LLCs to draft their bylaws to be consistent with some abstract notice of good corporate governance. LLCs are creatures of contract designed to afford the maximum amount of freedom of contract, private ordering and flexibility to the parties involved.”

The Court did allow expert testimony (a) on the requirements of federal securities law and, (b) citing an unreported opinion in the Court’s Wells Fargo v. First Interstate Banking litigation, as to the materiality of omissions as measured by the standards of federal securities law. Wells Fargo, relying on TSC v. Northway, had held that “issues of materiality are generally held to be mixed questions of law and fact but predominantly questions of fact.”

The pre-trial ruling is available here.

II. LLC Agreement Provisions
In the case in chief, the Chancellor granted TravelCenters’ declaratory judgment that the activist stockholder plaintiff’s notice of intended nomination of board members at the annual meeting (the “Notice”) was contrary to the LLC Agreement and “of no force or effect.”

The Court found that the Notice violated a requirement in the Agreement that such notices disclose all the information that the Exchange Act would require to be disclosed in a proxy solicitation. The decision was based on the legal proposition that LLC’s are “creatures of contract” and are not limited by general rules applicable to corporate governance. Since valid notice was required for the nominations to be accepted at the meeting, the management slate would be expected to be unopposed.

The bench memorandum is available here.

Corporate Governance Update: Advice for Directors in Complicated Times: The Fundamentals Still Apply

This post is from David A. Katz of Wachtell, Lipton, Rosen & Katz.

My colleague Laura A. McIntosh and I have written an article entitled Corporate Governance Update: Advice for Directors in Complicated Times: The Fundamentals Still Apply. The article considers directors’ oversight responsibility in a volatile business environment, including directors’ obligations as a company approaches the zone of insolvency and the extent to which directors are entitled to rely on management’s and experts reports, advice and decisions. The article also discusses directors’ exposure to potential liability, including the degree of vigilance required to discharge fiduciary obligations and how active directors should be in seeking information from management.

The Changing Dynamics of Global Capital Markets

This post is by Linda McKenzie of Ernst & Young.

In light of all of the recent market turmoil, the importance of transparency and risk management has certainly been elevated. These issues along with some of the shifts in global capital markets activity are at the center of a speech delivered by my CEO at Ernst & Young, Jim Turley, to a Washington D.C. audience at the U.S. Chamber’s 2nd Annual Capital Markets Summit. The speech describes how the interconnected, complex, and dynamic nature of global capital markets is demanding greater transparency, increased focus on risk management, and development of common standards and practices around the globe. Jim suggested the launch of a sustained multi-party dialogue — some mechanism involving issuers, auditors, and investors as well as governments and regulators — to facilitate a private and public sector dialogue that would monitor, assess, and address the challenges of operating in global capital markets and help to identify best practices. Tackling these issues could set a foundation for higher levels of investor confidence. The full text of the speech is available here.

The Geography of Block Acquisitions

This post by Jun-Koo Kang and Jin-Mo Kim is part of the series of posts on corporate governance articles accepted for publication in prominent Finance Journals.

Our forthcoming article in the Journal of Finance entitled The Geography of Block Acquisitions, extends the literature on geographic proximity by studying how corporate governance activities of block acquirers in targets and target announcement returns are affected when the acquirers are located near the targets.

Using a sample of 799 partial acquisitions in the U.S. during the 1990 to 1999 period, we find that:

  • Block acquirers exhibit a strong preference for targets located near them, indicating that geographic proximity plays an important role in determining acquirers’ choice of targets.
  • Geographically proximate block acquirers are more likely to be involved in post-acquisition governance activities in targets than are remote block acquirers. Specifically, we find that these acquirers are more likely to have their representatives on the target’s board and to replace poorly performing target management after block share purchases.
  • Geographically proximate targets experience both higher abnormal announcement returns and better post-acquisition operating performance than those of other acquisitions. The positive valuation effects are more pronounced when there are greater information asymmetries, and when acquirers have their representatives on the targets’ boards.

The full paper is available for download here.

Dangerous Dithering

This post is from Peter J. Wallison of the American Enterprise Institute.

It is often said of Congress that it can’t act on anything important except in a crisis. What is seldom noticed is the corollary that Congress puts off acting until ordinary problems develop into crises. For years, Congress has had before it two serious problems—the gradual loss of U.S. preeminence in financial transactions and the inadequate regulation of Fannie Mae and Freddie Mac—and has done nothing about either. This gives rise to a suspicion that we face these crises because a dysfunctional Congress can’t act until a crisis actually occurs. The developing situation with Fannie Mae and Freddie Mac is a test of this proposition. If the Senate Banking Committee doesn’t act on the current GSE legislation, which would give their regulator receivership powers, the outcome will be a crisis in which the necessary congressional action will be devastating for the taxpayers.

These issues are addressed in a recently circulated AEI Financial Services Outlook entitled “Dangerous Dithering: Congressional Inaction Plants the Seeds of Crisis”. It is available here.

Litigation Kennel?

This post is from Rodman Ward of Skadden, Arps, Slate, Meagher & Flom LLP. This post is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

Vice Chancellor Lamb’s recent memorandum opinion in the Delaware Court of Chancery, In Re SS&C Technologies, Inc. Shareholders Litigation, adds an interesting twist to the “readily available plaintiff” question.

The SS&C opinion and order imposes sanctions on the plaintiffs and their counsel for filing, in bad faith, a motion to withdraw. The defendants contended, and the Court found, that the motion was filed in an effort to cover up the discovery record relating to the “litigation spawning purpose” of a web of partnerships alleged to have been formed to provide plaintiffs in derivative and class litigation against publicly traded companies.

In the recent and well known Lerach and Weiss cases, the lawyers had ensured a stable of potential representative plaintiffs by paying them about ten percent of the attorney’s fees awarded by the court. In SS&C, the defendants allege that the managing partner of one of the plaintiff partnerships manages “a web of small investment partnerships – for the sole purpose of bringing stockholder lawsuits through his attorney.” Each of the nine investment partnerships cited “owns only a few shares … in roughly 60 to 80 public companies.” That would amount to about 500-700 companies subject to suit. Although the managing partner denied that the partnerships served only to bring stockholder lawsuits, he admitted that they were “economically irrelevant to him.” He acknowledged that he had, himself, been a party in fourteen proceedings and had been involved in “bringing roughly 30 stockholder lawsuits on behalf of himself and many of … [the partnerships].” The partnerships are consistently represented by the same law firm.

The Court’s opinion is highly skeptical of the managing partner’s claims. He and his counsel were found to have made a number of statements in documents filed with the Court which, the Court wrote, “are easily susceptible to the inference that they were made to conceal the existence of this web of partnerships and their evident litigation spawning purpose.” (emphasis supplied) The defendants, for their part, characterized the entire operation as “a litigation kennel.”

To support its findings, the Court sets out an extensive series of misstatements, mischaracterizations, inconsistencies and misrepresentations which the plaintiffs described at argument as “honest mistakes.” Although the Court could not find, based on the “sparse record before it,” that the partnerships could never serve as representative plaintiffs, it nevertheless sanctioned the plaintiffs for bad faith and abuse of judicial process in filing a spurious motion to withdraw as counsel.

The full opinion can be found here.

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