The Delaware Law Series

The Federalization of Corporate Governance

Marc I. Steinberg is the Radford Professor of Law at Southern Methodist University Dedman School of Law. This post relates to a recently published book by Professor Steinberg. Related research from the Program on Corporate Governance includes Federal Corporate Law: Lessons From History, by Lucian Bebchuk and Assaf Hamdani.

In my recently published book, The Federalization of Corporate Governance (Oxford University Press 2018) (ISBN 978-0-19-993454-6), I explore this process of federalization in the United States from 1903 to the present. Clearly, the states, particularly Delaware, traditionally have been and continue as principal regulators of the sphere of corporate governance. Nonetheless, to an increasing degree, the federal government, the SEC, and the national stock exchanges impact corporate governance standards. The book views this federalization as an evolutionary process that commenced at the beginning of the twentieth century. Going through periods of activism, gradual transition, and stagnation, the process intensified with the enactment of the Sarbanes-Oxley and Dodd-Frank Acts.

To view these Acts as representing a revolutionary transformation with respect to federal oversight of corporate governance is an exaggeration. Rather, they symbolize a period of enhanced activism whereby this federalization process was accentuated. From a historical perspective, between 1903 and 1914, 24 bills were introduced in Congress which sought to require federal chartering and/or the implementation of federal minimum substantive standards. During that era, both Presidents Roosevelt and Taft favored federal incorporation. Between 1914 and 1930, another seven bills were introduced in Congress seeking to effectuate similar objectives—with one such bill requiring that the Federal Trade Commission approve executive officer remuneration. Interestingly, the next significant legislative effort occurred 50 years thereafter with the Metzenbaum Bill of 1980 which prescribed federal minimum standards that largely focused on adherence to fiduciary duties, including with respect to related-party transactions. Although hearings were held through the years, none of these bills were enacted.


Clarifying Appraisal Rights in Complicated Transactions

Gail Weinstein is senior counsel, Steven Epstein and Warren S. de Wied are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Epstein, Mr. de Wied, Philip RichterAndrea Gede-Lange, and Maxwell Yim. This post is part of the Delaware law series; links to other posts in the series are available here.

Related research from the Program on Corporate Governance includes Using the Deal Price for Determining “Fair Value” in Appraisal Proceedings by Guhan Subramanian (discussed on the Forum here).

In City of North Miami Beach Genl. Employees’ Retirement Plan v. Dr Pepper Snapple Group, Inc. (June 1, 2018), the Court of Chancery held that appraisal rights are not available to the stockholders of Dr Pepper in connection with a transaction structure (involving a reverse triangular merger and a special cash dividend to the target stockholders) which will result in the sale of control of the company.

Key Points

  • The court confirmed that the Delaware appraisal statute does not bestow appraisal rights simply upon a sale of control—rather, appraisal rights are available only under certain statutorily-specified types of transactions.
  • The court indicated that it will not “look through” a transaction structure to the “underlying economic and practical effect” in order to grant appraisal rights when they are not otherwise specifically provided under a “plain reading” of the statute.
  • The court held that appraisal rights are not available to Dr Pepper’s stockholders because Dr Pepper (as a parent of the entity actually merging) is not a “constituent corporation” in the merger. The court held that, in addition, appraisal rights are not available because the Dr Pepper stockholders are not relinquishing their shares in connection with the transaction.
  • The Dr Pepper structure may be used in conflicted controller transactions, but, in our view, it is unlikely that it would be more broadly used for the purpose of eliminating appraisal rights (as discussed below under “Practice Points”).


Sandbagging in Delaware

Daniel E. Wolf is a partner at Kirkland & Ellis LLP. This post is based on their Kirkland & Ellis memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

In the private M&A context, “sandbagging” refers to a buyer, who despite having knowledge of a breach of representation or warranty by a seller at some time before closing, proceeds with the closing and then seeks indemnification from the seller for the breach of representation or warranty of which it had prior knowledge.

The popular belief among dealmakers has been that Delaware is generally “pro-sandbagging” meaning that, absent an express provision barring post-closing claims for known breaches (i.e., an “anti-sandbagging provision”), pre-closing knowledge of a breach is not a bar to seeking indemnification recovery as actual reliance by the buyer on the false representation is not a requisite component of a breach claim. Vice Chancellor Laster, in a 2015 transcript ruling, appeared to support this approach, saying:


Implementation of MFW Standard in New York

David Berger and Amy Simmerman are partners and Nate Emeritz is Of Counsel at Wilson Sonsini Goodrich & Rosati. This post is based on a WSGR publication by Mr. Berger, Ms. Simmerman, and Mr. Emeritz, and is part of the Delaware law series; links to other posts in the series are available here.

In another significant M&A decision from the New York Supreme Court, the controlling stockholder of a Delaware corporation failed to obtain judicial deference under the so-called “MFW” framework for its merger with the corporation. The MFW framework allows a controlling stockholder transaction that would otherwise be subject to the difficult entire fairness standard of judicial review in litigation to regain the protection of the deferential business judgment rule if the transaction is properly subjected to approval by an independent committee of the board of directors and the company’s minority stockholders. [1]

This new case, In re Handy & Harman Ltd. Stockholder Litigation[2] was decided by the same judge who recently enjoined Fujifilm’s acquisition of Xerox [3] and is important reading in the context of deals that might benefit from use of the MFW framework and for related litigation over Delaware corporations outside of the Delaware Court of Chancery. The case also reflects the ongoing stream of corporate litigation occurring outside of Delaware.


Post-Dell Appraisal—Still Work to be Done

Daniel E. Wolf is a partner and Gilad Zohari is an associate at Kirkland & Ellis LLP. This post is based on their Kirkland & Ellis publication, and is part of the Delaware law series; links to other posts in the series are available here.

Related research from the Program on Corporate Governance includes Using the Deal Price for Determining “Fair Value” in Appraisal Proceedings by Guhan Subramanian (discussed on the Forum here).

In the aftermath of the long-awaited Delaware Supreme Court appraisal decisions in Dell (which we reviewed in a previous note) and DFC, there was cautious optimism that the court’s guidance would eliminate or at least significantly reduce the uncertainty that surrounded appraisal proceedings in Delaware courts in recent years. It was hoped that the decisions would improve predictability and consistency in the application of different valuation metrics used to appraise the fair value of target companies.

In both Dell and DFC, the Supreme Court held that if the deal price resulted from a robust, informed and competitive process and arm’s-length negotiations, the trial judge would be required to assign substantial weight to the deal price as evidence of fair value in subsequent appraisal proceedings. While the Supreme Court did not take the final step of adopting a presumption in favor of deal price as the sole measure, the decisions strongly suggested that, if a deal resulted from a well-designed and competitive process, parties could expect that the deal price would be decisive in appraisal.


Caremark and Reputational Risk Through #MeToo Glasses

Arthur H. Kohn is partner and Elizabeth Bieber and Vanessa C. Richardson are associates at Cleary Gottlieb Steen & Hamilton LLP. This post is based on their Cleary Gottlieb publication and is part of the Delaware law series; links to other posts in the series are available here.

Public and private businesses today face many decisions that do not arise from, and have consequences far beyond, solely financial performance. Rather, these decisions are primarily driven by, and implicate, important social, cultural and political concerns. They include harassment, pay equity and other issues raised by the #MeToo movement; immigration and labor markets; trade policy; sustainability and climate change; the manufacture, distribution and financing of guns and opioids; corporate money in politics; privacy regulation in social media; cybersecurity; advertising, boycotts and free speech; race relations issues raised by the pledge of allegiance controversy; the financing of healthcare; the tension between religious freedom and discrimination laws; and the impact of executive pay on income inequality, among others. If the nature of the issues is not unprecedented, the number, diversity and polarization seem to be.


Proposed Amendments to Delaware’s LLC and LP Acts

John D. Seraydarian and Monica M. Ayres are Directors at Richards, Layton & Finger, P.A. This post is based on their Richards Layton publication and is part of the Delaware law series; links to other posts in the series are available here.

Legislation proposing to amend the Delaware Limited Liability Company Act (LLC Act) and the Delaware Revised Uniform Limited Partnership Act (LP Act) (jointly, the LLC and LP Acts) has been introduced to the Delaware General Assembly. The following is a brief summary of some of the more significant proposed amendments that affect Delaware limited liability companies (Delaware LLCs) and Delaware limited partnerships (Delaware LPs), including amendments (i) enabling a Delaware LLC to divide into two or more Delaware LLCs as a new permitted form of Delaware LLC reorganization, (ii) providing for the formation of statutory public benefit Delaware LLCs (Statutory Public Benefit LLCs), (iii) authorizing the creation of a new type of Delaware LLC series known as a “registered series,” and (iv) providing specific statutory authority for the use of networks of electronic databases (including blockchain and distributed ledgers) by Delaware LLCs and Delaware LPs. If enacted, all of the proposed amendments will become effective on August 1, 2018, except that the proposed amendments relating to Delaware LLC series will not become effective until August 1, 2019.


Continued Compensation to Incapacitated Controllers

Ning Chiu is counsel at Davis Polk & Wardwell LLP. This post is based on a Davis Polk publication by Ms. Chiu, and is part of the Delaware law series; links to other posts in the series are available here.

Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here), and The Untenable Case for Perpetual Dual-Class Stock by Lucian Bebchuk and Kobi Kastiel (discussed on the Forum here).

In an unusual finding, the Delaware Court of Chancery held that demand was partly excused and claims for corporate waste, bad faith and unjust enrichment could proceed against CBS Corporation for compensation paid to its former Executive Chairman, Sumner Redstone, who later became Chairman Emeritus. The plaintiff alleged that Mr. Redstone became incapacitated yet continued to receive compensation for work he did not perform.

The court noted that claims of corporate waste and bad faith require a plaintiff to show that the board’s decision was “so egregious or irrational” that it could not be based on a valid assessment of a company’s best interest, and amount to an “extreme factual scenario.” In making its determination, the court reviewed the salary payments made to Mr. Redstone as Executive Chairman pursuant to an employment agreement. Under the agreement, the compensation committee could only increase, but not decrease, Mr. Redstone’s salary. Either party could also terminate the agreement. The agreement required Mr. Redstone to be “actively engaged” in working with the board and management, including providing overall leadership and strategic direction, offering guidance and support, coordinating board activities and communicating with shareholders.


Delaware’s Unwarranted Assumption in DCF Pricing

Arthur H. Rosenbloom is Managing Director of Consilium ADR LLC, and Gilbert E. Matthews is Senior Managing Director and Chairman of the Board of Sutter Securities, Inc. This post is based on their recent paper and is part of the Delaware law series; links to other posts in the series are available here.

Every valuator’s kit bag includes income-based approaches such as discounted cash flow or the direct capitalization of earnings, by which to determine fair value or value using other standards.

Delaware fair value proceedings have predominantly adopted the erroneous assumption that capital expenditures should equal the sum of depreciation and amortization in determining terminal value. The assumption makes sense only if one assumes the non-real-world scenario of both no growth and no inflation, as we demonstrate in more detailed fashion in the next section of this article.


The Demand Review Committee: How it Works, and How it Could Work Better

Collins J. Seitz, Jr. is a Justice of the Delaware Supreme Court; and S. Michael Sirkin is a Partner at Ross Aronstam & Moritz LLP. This post is based on their recent article, published in The Business Lawyer, and is part of the Delaware law series; links to other posts in the series are available here.

In Delaware, stockholder derivative litigation follows a familiar path. The plaintiff files a complaint, alleging that demand is futile. The defendants move to dismiss under Court of Chancery Rule 23.1, arguing that the plaintiff failed to make a demand on the board of directors to bring the suit on behalf of the corporation. The motion is usually coupled with a motion to dismiss under Court of Chancery Rule 12(b)(6) for failure to state a claim. If the Court of Chancery grants the motion to dismiss on either ground, the matter ends.

What happens, though, if instead of pleading demand futility, the plaintiff actually makes a litigation demand? This path appears to be traveled less frequently, and appears to be less well understood by practitioners and directors. By making a demand on the board, the would-be plaintiff concedes that demand is not futile and that a majority of the board is capable of impartially considering the demand. As a result, an aggrieved stockholder who believes that the corporation is sitting on a valuable claim faces a stark choice between making a demand and attempting to plead demand futility.


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