The Hidden Logic of Shareholder Democracy

In the Hidden Logic of Shareholder Democracy, I examine the basic rules of shareholder voting. I begin with a simple observation: In Delaware, voting rules specify different voting populations, depending on the type of vote at issue. When shareholders vote on ordinary business matters, the voting formula focuses on the number of votes cast, once a quorum is achieved. For example, approval of shareholder-proposed bylaw amendments requires a majority of votes cast. The rules are even less demanding for director elections, which require merely a plurality of votes cast.

For fundamental changes to the corporation—things like a merger, amendments to the certificate of incorporation, or dissolution—the shareholder polity changes. In these cases, the board must recommend a proposal to the shareholders, and passage requires the affirmative vote of a majority of shares outstanding, which I term an absolute majority. That is, instead of hinging on the number of shares that vote, these fundamental changes require a majority of all outstanding shares, regardless of whether the shares are voted. It requires only a little mental arithmetic to appreciate the importance of this difference: Given that quorum is by default a majority, if an item only requires a majority of votes cast once quorum is established, then 25.1% of outstanding shares could be enough to approve it. An absolute majority, in contrast, requires a minimum of 50.1% of all shares, no matter what.

I draw three main conclusions from this simple observation about voting rules. First, it is a mistake to think of shareholder democracy as a unitary phenomenon. Shareholder voting rules vary because shareholder votes have different meaning depending on their context. In fact, I identify four different kinds of shareholder votes, each with its own function in corporate law. Second, I argue that these differences in voting rules exist by design. Most importantly, the increased difficulty in obtaining a shareholder vote on fundamental decisions is a feature, not a bug, if you will.  It is no accident that the Delaware General Corporation Law (DGCL) makes it harder for management to make fundamental changes to the corporation; after all, these decisions are central to the very character (and sometimes, existence) of the corporation itself. My third, and final, conclusion is that the 2023 amendments to the DGCL, by changing the rules with respect to specific certificate amendments, broke with Delaware tradition and destabilized the basic balance of shareholder voting.

The initial point to establish is that there are four different types of shareholder votes. The first type of voting, volition voting, has the clearest parallel to the political sphere. It comprises two different settings: First, and most familiarly, shareholders vote for their representatives—the directors of the corporation, who will make decisions for them.[1] The second setting for the volition vote is much rarer, taking place when shareholders exercise their power to amend the bylaws, a power they can exercise on their own, independently of the directors.[2] I term these cases “volition votes” because when they occur, shareholders are affirmatively exercising their will to change the corporation’s governance. Again, this type of vote requires a majority (or plurality) of votes cast, once a quorum (typically a majority of shares outstanding) has been achieved.

A related category is precatory voting. When shareholders make precatory resolutions, they are asking their representatives to take specific action. While boards of directors do well to heed these precatory votes, such votes (alone among the other categories) lack any formal corporate effect.  Shareholder votes ratifying a choice of accountant, say on pay, and similar matters fall into this precatory category.

The third type of shareholder voting— “veto” voting—operates in an entirely different way from the first two. Decisions that “fundamentally alter the corporate contract,” like the making of amendments to the corporate charter or the fundamental restructuring of the entity by way of a merger or a transformative sale of corporate assets, qualify as veto votes. As described above, they require an absolute majority—that is, they focus on the number of shares outstanding. A chief ramification of the change in denominator is that, unlike with a volitional vote, a shareholder’s failure to vote is tantamount to a “no” vote.

The fourth type, the “vetting vote,” allows shareholders to approve conflicted transactions. Here the board seeks a shareholder vote that it would not otherwise require (in the case of volitional votes, such as shareholder approval of a specific stock grant to a controlling shareholder), or imposes more stringent voting requirements on a transaction that requires a veto vote (a “veto+” (majority of the minority) vote).

The vetting vote has increased in importance because of cases like Corwin and MFW, which provide circumstances in which a disinterested and fully-informed shareholder vote can restore business judgment rule protection to conflicted transactions, which would otherwise be subject to more rigorous entire fairness analysis.  In the recent Match.com decision, the Delaware Supreme Court both reiterated the importance of the vetting vote and clarified that such votes are not enough on their own to restore business judgment protection.

*except for changes in the number of authorized shares, per 2023 DGCL amendments

Having described this voting typology, I move to my second claim: These differences in vote architectures are by design. The veto vote, with its requirement of an absolute majority, is more demanding because fundamental changes are the core area of concern for shareholders. Given the special importance of these matters, it only makes sense that the DGCL makes it harder to obtain the veto vote.

I make the case by way of the history and the structure of the DGCL itself. Right from the start, when the DGCL imported its corporate law from New Jersey in 1899, it provided voting rules for the veto vote. The original rule, indeed, required unanimity for such changes; New Jersey reduced it to 2/3 and Delaware to a majority—but always of outstanding shares. In contrast, and perhaps surprisingly, the DGCL did not set out volitional voting rules until 1981. Until then, voting rules regarding director votes and ordinary business decisions were left up to individual corporations to decide—even though Ernest Folk specifically suggested providing such voting rules beginning in the mid-1960s.

This history explains why, structurally, the votes remain separated to this day. Every Delaware practitioner knows that Section 216 sets out volitional voting rules. They also know that the rules for the veto vote appears in an entirely different section, Section 242. Two different sections, two different voting formulas: the logical implication is that shareholder votes for fundamental corporate changes are, in fact, different kinds of votes.

Another structural matter offers a clue as to the “don’t tread on me” purpose of Section 242: The rules for amending the certificate are different if the corporation has not received payment for its shares. Until shareholders have paid in capital, Section 241 applies, and a majority of the incorporators or directors have the power to amend the certificate unilaterally. Management can change the fundamental rules of the game with impunity.

But after shareholders have paid for their shares—after they have committed corporate capital—they have made themselves vulnerable. The board could opportunistically change the rules of the game to disadvantage them and leave them without recourse. Thus, Section 242 long provided that, after shareholders have paid in capital, amendments to the certificate require the approval of a majority of outstanding shares.

In sum, it is supposed to be harder to make these kinds of fundamental changes, precisely because they are fundamental. But with the resurgence of retail shareholders, corporations have chafed at the requirement that they must secure approval of a majority of outstanding shares.  To take perhaps the most prominent example, AMC shot up in value over the course of the COVID-19 pandemic and was traded widely by a large retail-shareholder base. It capitalized on its meme-stock status by issuing more shares, raising over a billion dollars from an enthusiastic shareholder base in roughly ten months’ time.

But then AMC ran out of authorized shares to sell. To obtain more shares, it had to amend its certificate. It attempted to get the vote required to do so and failed. Twice. AMC management claimed that its largely retail shareholder base was either inattentive or failed to understand that the future of the company was at stake. Yet many shareholders throughout AMC’s struggles and subsequent litigation voiced a fear that the issuance of more shares would dilute their own interests. This concern may have been misguided, given the company’s urgent need for more capital.  Or it might have been a quite rational fear of dilution.

In any event, AMC management faced a problem. As we have seen, Delaware requires a veto vote for amendments to the charter, in order to stop corporate managers from changing the fundamental rules of the corporation without an absolute majority of shareholders. AMC solved its problem with a creative work-around: AMC Preferred Equity Units (“APEs”), shares that were already authorized by the certificate, with so-called “blank check” features that allowed the board to later designate the specific rights and powers of the shares. The niceties of the APEs do not concern us, but they included a “mirror voting” feature which effectively removed the “nonvote equals a no-vote” problem of the traditional veto vote. Many shareholders, including supposedly apathetic retail shareholders, vociferously objected, and the company eventually settled litigation regarding the legality of the APEs.

More importantly for our purposes, around the time of the AMC litigation, the Delaware General Assembly considered and eventually adopted new amendments to the DGCL, changing the formula for the veto vote in narrow categories of certificate amendments, generally dealing with increases in the number of authorized shares. Collectively, these amendments increased the power of the board to act without the need for a veto vote—in one case, without any vote at all. Neither the Council of the Corporation Law Section of the Delaware State Bar Association (the “Council”) nor the Delaware legislature has explained the rationale behind these changes, or why they apply to only two specific areas of the veto vote, other than to assert that “many public corporations have encountered significant difficulty in securing various stockholder votes and, in particular, a vote necessary to effect a reverse stock split to help a corporation maintain the minimum share price amount necessary to be listed on a national securities exchange.”

These legislative changes—notably not limited in application to the circumstances where there is a threat of delisting—are troubling, to say the least. The veto vote has long applied an absolute-majority requirement for a reason: because it makes sense to give shareholders especially robust protection when it comes to fundamental corporate changes. Thus, we arrive at my third claim: maintaining a votes-cast standard for some veto votes and an absolute-majority standard for others goes against the hidden logic of Delaware’s shareholder democracy. By doing so, it destabilizes the traditional protection the veto vote affords and risks internal incoherence in the DGCL.

Endnotes

1 Del. Code. Ann. tit. 8, § 211(b) (2023).(go back)

2 Del. Code. Ann. tit. 8, § 109 (2023).(go back)