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E-MailLawrence A. Hamermesh is Executive Director of the Institute for Law and Economics at the University of Pennsylvania, and Emeritus Professor at Widener University Delaware Law School. Jack B. Jacobs is Senior Counsel at Young Conaway Stargatt & Taylor, LLP, and former Justice of the Delaware Supreme Court and Vice Chancellor of the Court of Chancery. Leo E. Strine, Jr. is the Michael L. Wachter Distinguished Fellow at the University of Pennsylvania Carey Law School; Senior Fellow, Harvard Program on Corporate Governance; of counsel, Wachtell, Lipton, Rosen & Katz; and former Chief Justice and Chancellor, the State of Delaware. This post is based on their paper forthcoming in The Business Lawyer, and is part of the Delaware law series; links to other posts in the series are available here.
In our article, Optimizing The World’s Leading Corporate Law: A 20-Year Retrospective and Look Ahead, we look back at a 2001 article (Function Over Form: A Reassessment of Standards of Review in Delaware Corporation Law) in which two of us, with important input from the other, argued that in addressing issues like hostile takeovers, assertive institutional investors, leveraged buyouts, and contested ballot questions, the Delaware courts had done exemplary work but on occasion crafted standards of review that unduly encouraged litigation and did not appropriately credit intra-corporate procedures designed to ensure fairness. Function Over Form suggested ways to make those standards more predictable, encourage procedures that better protected stockholders, and discourage meritless litigation, by restoring business judgment rule protection for transactions approved by independent directors, the disinterested stockholders, or both.
Our current paper examines how Delaware law responded to the prior article’s recommendations, concluding that the Delaware judiciary has addressed most of them constructively, thereby creating incentives to use procedures that promote the fair treatment of stockholders and discourage meritless litigation. The continued excellence and diligence of the Delaware judiciary is one of Delaware corporate law’s core strengths.
But some recent cases have articulated standards of review that involve greater than optimal litigation intensity and less than ideal respect for decision-making in which independent directors and disinterested stockholders have potent say. Those standards also impair the integrity of Delaware’s approach to demand excusal in derivative cases and the identification of controlling stockholders. Our major recommendations for addressing the concerns we identify are:
- Restrict the Lynch inherent coercion doctrine and the bespoke MFW solution to it to the domain of going private mergers and tender offers with controlling stockholders or mergers with another company that the controller also controls. This will reduce the unhelpful pressures by plaintiffs to characterize as “controlling stockholders” defendants who have far less than majority ownership, and unaffiliated defendants as a “situational control bloc.” Interested transactions would be treated symmetrically and not receive starkly different treatment simply because of the characterization of the interested party defendants.
- For other self-dealing transactions within the meaning of DGCL § 144, restore symmetry among interested transactions by reaffirming, per traditional Delaware equity law, that any of the traditional cleansing protections invokes business judgment review if used with integrity.
- Require plaintiffs challenging so-called “non-ratable benefits” to fiduciaries to prove that the non-ratable benefit resulted from a breach of fiduciary duty of loyalty and caused specific damage to the company and other stockholders. If the non-ratable benefit was approved by one of the traditional cleansing protections, the business judgment rule should apply.
- Apply the second prong of Aronson to provide for demand excusal when the particularized pled facts support an inference of a non-exculpated breach of duty by any director — thereby preserving Aronson’s important integrity-reinforcing role in Delaware law. In any event, harmonize the deference to decisions by independent directors by according them at least the same level of respect in the less difficult realm of policing transactions up front as in determining whether to sue after the fact.
- Remove old encrustations on Delaware law that make it unclear and do not add value:
- Eliminate the waste vestige qualifying the effect of an informed, disinterested stockholder vote.
- Formally overrule Cede II’s effort to impose and link layers of standards of review applicable in disparate contexts.
- End Delaware takeover law’s reliance on the concept of substantive coercion, and hold that Unocal permits a board acting in the reasonable, good faith belief that a tender offer is too low to use a pill to block the bid, based on power allocation grounds and not on the premise that stockholders might harm themselves by ignoring the board’s contrary view of value.
The remaining two of our recommendations – unlike the previous ones that could be accomplished by common law adjudication – would require legislative action:
- Amend DGCL § 102(b)(7) to allow stockholders to adopt corporate charters exculpating officers for breaches of the duty of care claims brought by way of a class or representative action, but not for claims brought directly by the company itself under a contract or corporate common law.
- Restore balance to the litigation process by amending DGCL § 220 to require prompt production of core books and records, but preclude burdening companies and investors with what amounts to free ranging and expensive pre-filing discovery, especially where federal and state law already provide stockholders with a required and detailed information base on which to base a vote on, or challenge to, a transaction.
The complete paper is available for download here.
