Delaware’s Choice

In November 2013 I delivered the 29th Annual Francis G. Pileggi Distinguished Lecture in Law in Wilmington, Delaware. My lecture, entitled “Delaware’s Choice,” presented four uncontested facts from my prior research: (1) in the 1980s, federal courts established the principle that Section 203 must give bidders a “meaningful opportunity for success” in order to withstand scrutiny under the Supremacy Clause of the U.S. Constitution; (2) federal courts upheld Section 203 at the time, based on empirical evidence from 1985-1988 purporting to show that Section 203 did in fact give bidders a meaningful opportunity for success; (3) between 1990 and 2010, not a single bidder was able to achieve the 85% threshold required by Section 203, thereby calling into question whether Section 203 has in fact given bidders a meaningful opportunity for success; and (4) perhaps most damning, the original evidence that the courts relied upon to conclude that Section 203 gave bidders a meaningful opportunity for success was seriously flawed—so flawed, in fact, that even this original evidence supports the opposite conclusion: that Section 203 did not give bidders a meaningful opportunity for success.

I concluded my lecture with three questions for the audience:

• (1) Is the constitutionality of Section 203 settled law?
• (2) If not, would a bidder be well-advised to challenge the constitutionality of Section 203 the next time it becomes a binding constraint in a takeover situation?
• (3) And if yes, what, if anything, should Delaware do to avoid this challenge?

I, along with numerous prominent academics and practitioners, believe the answer to the first question is no. Professor Joe Grundfest of Stanford Law School told the Wall Street Journal: “Lawyers now have the data they need to renew a constitutional battle over these sorts of state takeover laws.” Professor Steve Bainbridge of UCLA Law School wrote on his popular blog: “I agree that the article’s data calls into question the empirical grounding of the Delaware trilogy. To that extent, I agree that the validity of the Delaware statute could be challenged.” In an upcoming commentary to my Pileggi Lecture that will also be published in the Delaware Journal of Corporate Law, Steve Shapiro, an appellate lawyer in Chicago and Deputy Solicitor General in the Reagan Administration, wrote along with his co-author Dorothy Shapiro: “What would federal courts think of the Delaware statute if Professor Subramanian’s factual findings were presented today? In our view, the statute would be declared unconstitutional.” Even without the benefit of the data, the definitive securities law treatise by Loss, Seligman, and Paredes states: “[T]he New York and Delaware statutes vest existing managers with the power to block tender offers, and thus appear to be inconsistent with the Williams Act.” And A. Gilchrist Sparks III, a prominent and well-respected partner at Morris, Nichols in Wilmington and Chair of the Corporate Law Council in 1988, conceded in a rebuttal to my Pileggi Lecture that the constitutionality of Section 203 is not definitively settled law.

This then raises the second question: would a bidder be well-advised to challenge the constitutionality of Section 203 the next time it becomes a binding constraint in a takeover situation? As I pointed out in my Pileggi Lecture, why wouldn’t a bidder challenge the constitutionality of Section 203 in the next no-holds-barred, spare-no-expense hostile takeover contest? In my conversations with senior Delaware practitioners around the time of my Pileggi Lecture, I failed to get an answer—any answer—to this question. Indeed, in my experience studying all hostile takeover bids since 1995 (n=252), and as an expert witness myself in several hostile takeover situations over the past 15 years, a challenge to Section 203 would be far more plausible than many claims that are regularly brought in hostile takeover situations.

This then raises the difficult question: what, if anything, should Delaware do to avoid this challenge? Specifically, should Delaware take a wait-and-see approach, or should Delaware get “out in front” of the issue by amending the statute to make it constitutionally secure? The Council of Corporation Law, which writes the corporate law of Delaware, generally takes a conservative approach to amending Delaware’s corporate code. Those who advocate a wait-and-see approach argue that the Council could simply put in a replacement antitakeover statute, presumably with a lower threshold, if Delaware were to lose the inevitable constitutional challenge. One prominent Delaware attorney suggested to me that the Delaware legislature would defer to the Council on a replacement statute, as it does on all other corporate law amendments. But this argument is incorrect, because a state antitakeover statute is a fundamentally different animal than other amendments to the Delaware corporate code. A proposed replacement to Section 203 would trigger a national debate played out on the Delaware stage. The lobbying would shift from Wilmington (where most Delaware corporate law practitioners are based) to Dover (where the Delaware legislature sits). The Council would have much less control over a public process that played out 50 miles to the south. As Gil Sparks put it in his response to my Pileggi Lecture, a proposed replacement statute would be a “big big deal, with an uncertain outcome.”

Imagine the lobbying of ISS and activist investors against such a proposed statute—constituencies that were virtually non-existent in 1988 when Section 203 was passed. ISS, in particular, would “go to the mat” to oppose a new antitakeover statute, after having spent most of the past ten years beating back the pill. The idea that the Council could simply recommend a replacement statute, which would then be adopted by the Delaware legislature, ignores both the historical experience and the political realities of today. All of this points to the conclusion that the Council should act. In their commentary, Shapiro & Shapiro agree with this assessment: “Should the Delaware legislature avoid this development on the theory that sleeping dogs are best left undisturbed? The answer, we believe, is no.”

Specifically, Delaware should amend Section 203 to change the 85% hurdle to 70%. This amendment—to a single number—would put Section 203 on solid constitutional ground. It would also represent good policy: facilitating high-premium offers that attract a supermajority of disinterested shares, but also providing companies with reasonable insulation against opportunistic low-ball offers.

Delaware has a well-known interest in maximizing its share of the corporate charter marketplace. Delaware could meet this interest by proactively amending Section 203, rather than risking constitutional invalidation of Section 203 and being left with no antitakeover statute whatsoever. Political and popular sentiment have shifted considerably since 1988, toward far greater acceptance of hostile tender offers as an important “disciplinary” mechanism that improves allocational efficiency in the marketplace. If Delaware lost Section 203 to constitutional challenge, it would be far more difficult than it was in 1988 for the Delaware legislature to replace it with a new antitakeover statute. Because amending the existing statute is more politically viable than installing a new one, the Delaware legislature should be proactive rather than reactive on Section 203.

The lecture will be published in a forthcoming issue of the Delaware Journal of Corporate Law, and is available in draft form here. The prior articles, published in the Business Lawyer, are available here and here.

A video of the lecture, including a welcome by Professor Larry Hamermesh, an introduction by Chancellor (now Chief Justice) Leo Strine, my presentation, and a rebuttal from Gil Sparks, is available here.  (video no longer available)

In addition to Shapiro & Shapiro, Joe Grundfest (Stanford Law School), Larry Hamermesh (Widener Law School), the Honorable Travis Laster (Delaware Court of Chancery), and Norman Monhait (Rosenthal Monhait & Goddess; and Chair of the Delaware Corporate Law Council) will write commentaries, which will also appear in the Delaware Journal of Corporate Law this spring.