Majority Rules

The “disinterested and independent board majority” is one of the most important concepts in corporate law, because it is the fulcrum on which most corporate litigation turns. Where such a majority is present, it is virtually impossible for plaintiff-shareholders to win a lawsuit.

In keeping with its importance, disinterestedness and independence receive ample judicial attention.[1] Scholars likewise ask hard questions about disinterestedness and independence. Can a director be truly impartial when evaluating a merger proposed by the shareholder who appointed her to the board? Can a director fairly decide whether to sue the CEO alongside whom he has worked for years and shares numerous social ties?

Yet something is missing from both the cases and commentary: a majority independence test is a majority independence test.

Once we agree about who is interested and who is disinterested, we still need to ask whether the resulting numerical composition counts as a disinterested majority. For example, once we determine that Directors X and Y are independent (but Z is not), it still remains whether to ask whether the XYZ board gets the protection majority independence brings. So, what is a “majority?” In stark contrast to the voluminous literature analyzing “independence,” almost no attention has been paid to the question of “majority.”

No doubt, the notion of majority has received scant attention because it strikes most people as utterly uncomplicated: a majority means more than half! Seemingly, once we agree on who is independent, all that is left to do is “count heads.” The forgoing XYZ board has a disinterested majority because two directors are disinterested and one is not. Can there be any grounds for disagreement?

Yet it turns out that “majority” means different things to different courts, even to different Delaware Chancellors. The seemingly innocuous notion of “majority” admits of numerous permutations. Indeed, there may be no majority rule when it comes to the disinterested majority rule.

One common version of the test finds a disinterested majority when the independent directors mostly approved of a given transaction.[2] Another version of the test asks whether the directors were mostly independent approvers.[3] Yet another version asks whether a majority of the board was independent, regardless of how anyone voted.[4]

The difference in rule often means a different result. Consider the XYZ board from above, and imagine that the disinterested directors (X and Y) split evenly between affirming and dissenting, while the conflicted director (Z) votes in favor of the transaction. For illustration, imagine the board is voting to sell corporate property to Z.

Was the transaction approved by a disinterested majority? For some courts, the answer is “yes.” These courts would point out that two out of three directors were disinterested. However, other courts would answer “no.” They would reason that independent and approving directors did not constitute a majority (only one third of the board met both conditions).[5] Other courts would answer “no” for a completely different reason: less than a majority of the disinterested directors (1/2) affirmed.[6]

The three tests often give different answers to the question of disinterested majorities because they are measuring majorities of different things. Whether the board must endure months of litigation and risk personal liability, whether the plaintiff will have any hope of righting a perceived wrong, will turn on which sort of majority the court is looking for.

In a forthcoming Article, I explore the notion of a “disinterested majority” with my focus exclusively on the “majority.” Such an inquiry is warranted for at least four reasons. First, it goes to the heart of one of the greatest muddles in contemporary corporate law: conflict of interest rules. Delaware law has become hopeless confused on the issue.[7] Subtly different disinterested majority rules are at the heart of the confusion.

Second, it makes a great practical difference to litigants what rule is applied to them. Different rules mean litigants encounter contingent and unequal results in real cases. This might be palatable if we were confident that courts were making predictable, or even principled, choices about which rule to apply. Unfortunately, there is no indication that courts are even aware that they are making a choice in determining what sort of “majority” is present. Likewise, scholars and litigants do not seem to appreciate that there are significant differences between different rules. The central legal issue in some corporate disputes may well be an issue that no one has seen: the conception of “majority” that the court uses. Advocates should be clear about what they are asking for, and judges should be clear about what they are giving. Only conceptual clarity makes that possible.

A third reason for problematizing the seemingly innocuous concept of “majority” is precisely because of how unproblematic the term otherwise strikes us. Here we have a concept that is mentioned in literally thousands of judicial decisions, but which has not been noticed as crucially ambiguous, leading real courts to unknowingly split on essentially the same facts. This inquiry into independent majorities is a reminder that important mysteries may hide in plain sight – and it also serves as an antidote to our tendency to pass over such puzzles in other areas of law.

Fourth, scholars far afield of corporate law should care what corporate law makes of a disinterested majority. Other areas of law must contend with similar questions – judicial panels, democratic elections – in which collective bodies deliberate despite heterogenous membership. When does the partiality of a member tarnish the group? Corporate law has consciously and unconsciously grappled with this question for years and its path may prove informative to other domains.

How should courts think about “majority?” It is tempting to think that the answer falls directly out of the statutory language governing conflicts. If the statutes don’t resolve things, one might turn to policy: specifically, those who favor shareholder power should favor the most restrictive definition of majority (and vice versa). If such policy analysis doesn’t resolve things, then perhaps this whole debate is semantic and nothing turns on it.

None of these inferences are sound. The positive law does not satisfactorily fix the proper rule. The rules cannot be stacked up from most to least exacting; they are incommensurable such that neither board critics nor apologists should have a strong or strict preference among them. Nor does that indeterminacy (much less the collegial culture of the board) defeat the importance of this analysis.

To the contrary, there are fruitful grounds for differentiating among the rules. To understand these differences requires understanding the teleology of these rules. The law puts directors in the crosshairs of litigation and then releases when a majority rule is satisfied. Why? I suggest that three bases are imminent in the three rules: deference, evidence, and incentive. Once we surface these principles, we are free to ask whether we endorse them and the majority rule that best advances one or another.

Endnotes

1Here, I largely conflate “independence” and “disinterestedness” for ease of exposition. They are different concepts, but they are both necessary conditions for board protection. A blemish on either property disqualifies a director from appearing in the numerator of any majority ratio. (go back)

2E.g., Cooke v. Oolie, 2000 WL 710199 (Del. Ch. 1999).(go back)

3E.g., Chaffin v. GNI Grp., Inc., 1999 WL 721569 (Del. Ch. 1999).(go back)

4E.g., Garnett v. Chen, 2012 WL 5337401 (Del. Ch. 2012).(go back)

5See infra Part II.A.1.(go back)

6See infra Part II.A.2.(go back)

7See generally, William Bratton, Reconsidering the Evolutionary Erosion Account of Corporate Fiduciary Law, https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3753589.(go back)