The Delaware Law Series

Upstream Liability, Entities as Boards, and the Theory of the Firm

Andrew Verstein is Professor of Law at Wake Forest University School of Law. This post is based on his recent article, forthcoming in The Business Lawyer.

Directors have fiduciary duties, and the most litigated and most demanding of those duties is the duty of loyalty. The key questions for duty of loyalty litigation are director-by-director questions: Did this particular director have a conflict? Is it futile to make a demand on that particular director?

What does it mean to ask director-by-director questions if corporations have just one director, which is itself an entity? Shall we inquire about particular humans in the managing entity or limit our analysis to the entity itself? The question becomes richer and more important if the board-entities opt to bundle services: We know how to evaluate a conflict when a director urges the company to patronize her own accounting or banking firm. How should we evaluate the conflict if a managing entity opts to use its own accounting or banking department? Our conflict analysis is usually of contractual transactions but the essence of the Coasian firm is the absence of a contract to analyze. In a recently published essay, I explore how the duty of loyalty might work when entities manage entities and uncover important lessons about how loyalty works.

The impetus for the article is Outsourcing the Board, a book in which Professors Steve Bainbridge and Todd Henderson advocate that a legal entity (a “board service provider” or BSP) should be permitted to serve as the sole director of a corporate board.


Rent-A-Center: A $1.37 BN Reminder on Reminders

Rachel Fridhandler is an associate at Sidley Austin LLP. This post is based on a Sidley memorandum by Ms. Fridhandler, Asi Kirmayer and Scott Freeman, and is part of the Delaware law series; links to other posts in the series are available hereRelated research from the Program on Corporate Governance includes M&A Contracts: Purposes, Types, Regulation, and Patterns of Practice and Allocating Risk Through Contract: Evidence from M&A and Policy Implications (discussed on the Forum here), both by John C. Coates, IV. 

Rent-A-Center Inc., a Texas based consumer goods rent-to-own retailer (R-A-C) most famous for enabling generations of North Americans to fill their homes with furniture, electronics and household appliances, agreed in June 2018 to a buyout by affiliates of the private equity firm, Vintage Capital Management, LLC (Vintage) in a deal valuing the R-A-C at $1.37 billion (including debt). The transaction, which was subject to customary closing conditions and regulatory approvals, included the nearly universal provision entitling either party to terminate the transaction if it did not close by a specified end date (which date could be extended by either party delivering a written notice to the other of its desire to extend). Perhaps unsurprisingly to readers, given the publication of this article (and many others) on what was otherwise a fairly straightforward merger, the specified end date came and went without either R-A-C or Vintage giving the other notice of a desire to extend. After complex litigation between the parties about an allegedly simple failure to give (an arguably unnecessary) notice, Vice Chancellor Glasscock, in Vintage Rodeo Parent LLC, et al v Rent-A-Center, determined that R-A-C need not go through with the sale even though the parties (at the time) had appeared to understand that the end date would be extended and had continued to work on satisfying the other closing conditions.


Delaware’s New Competition

William J. Moon is Assistant Professor of Law at the University of Maryland. This post is based on his recent article, forthcoming in the Northwestern University Law Review. Related research from the Program on Corporate Governance includes The Market for Corporate Law by Oren Bar-Gill, Michal Barzuza, and Lucian Bebchuk; Federal Corporate Law: Lessons from History by Lucian Bebchuk and Assaf Hamdani; Delaware Law as Lingua Franca: Evidence from VC-Backed Startups by Brian Broughman, Darian Ibrahim, and Jesse Fried, and (discussed on the Forum here); and Delaware’s Competition by Mark J. Roe.

American corporate law is built on a metaphor of a race: states compete to supply corporate law. For nearly half a century, corporate law scholarship has revolved around endemic questions about whether other states put competitive pressure on Delaware, and whether this competition is normatively desirable.

There is a missing piece to this important body of scholarship. In my article, Delaware’s New Competition (forthcoming in the Northwestern University Law Review and available on SSRN), I introduce foreign nations as emerging lawmakers that compete with American states in the increasingly globalizing market for corporate law. In recent decades, entrepreneurial foreign nations in offshore islands—principally the Cayman Islands, the British Virgin Islands, and Bermuda—have attracted publicly traded American corporations by offering permissive corporate governance rules and specialized business courts.


Mootness Fees

Steven Davidoff Solomon is Professor of Law at UC Berkeley School of Law. This post is based on a recent article, forthcoming in Vanderbilt Law Review, authored by Professor Davidoff Solomon; Matthew D. Cain, Visiting Research Fellow at the Harvard Law School Program on Corporate Governance; Jill Fisch, Saul A. Fox Distinguished Professor of Business Law and Co-Director, Institute for Law and Economics at the University of Pennsylvania Law School; and Randall S. Thomas, John S. Beasley II Chair in Law and Business at Vanderbilt Law School. Related research from the Program on Corporate Governance includes Federal Corporate Law: Lessons from History by Lucian Bebchuk and Assaf Hamdani. This post is part of the Delaware law series; links to other posts in the series are available here.

In Mootness Fees, forthcoming in the Vanderbilt Law Review, we document the latest development in merger litigation, mootness dismissals. In 2016, the Delaware courts announced in In re Trulia that they would no longer approve merger litigation settlements which provided for a release and an award of attorneys’ fees if they did not achieve meaningful benefits for shareholders. Trulia, coupled with other substantive changes in Delaware law, reduced the attractiveness of merger litigation in Delaware.

Delaware’s crackdown did not put an end to merger litigation, which, as we document in prior work, had become ubiquitous however. Instead, the changes resulted in the flight of case filings from Delaware to the federal courts. These federal suits repackaged state-law fiduciary duty claims into antifraud actions under Section 14A and Rule 14a-9 thereunder. By 2017, merger litigation rates, which had dipped to 74% of deals in 2016, rose to 83%, but only 10% of litigated deals faced a challenge in Delaware versus 87% in federal court. By 2018, the numbers were even more dramatic—5% of litigated deals were challenged in the Delaware courts, but 92% gave rise to a federal court lawsuit.


Investors Bancorp‘s Impact on Long-Term Incentive Plans

Matthew B. Grunert and Scott C. Sanders are partners and Jackie Z. Coleman is an associate at Bracewell LLP. This post is based on their Bracewell memorandum, 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 Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here).

The trend of including director-specific limits on the size of annual equity awards to non-employee directors under long-term incentive plans (“LTIPs”) continues to pick up steam, as evidenced by our survey of LTIPs filed this proxy season for shareholder approval. Nearly 75% of LTIPs reviewed now include a director-specific limit on the size of annual non-employee director grants, with a majority of those LTIPs restricting not only the size of annual equity awards, but also capping total annual compensation to non-employee directors.

This trend’s beginnings arose from the 2017 Delaware Supreme Court decision in In re Investors Bancorp, Inc. Stockholders Litigation (“Bancorp”). In Bancorp, the court held that a shareholder-approved cap on the aggregate number of shares that could be granted to non-employee directors under the company’s LTIP did not constitute shareholder ratification of the subsequent individual awards granted to non-employee directors of Investors Bancorp. As a result, the court held that the “entire fairness standard” should apply to any review of the size of non-employee director awards, requiring the board to demonstrate that the awards were fair to the company, as opposed to permitting application of the more company-friendly “business judgment rule,” requiring a showing by the plaintiff of corporate waste.


Sometimes Silence is Golden: “Dell Compliance” Following Aruba III

Michael Kass is Portfolio Manager at BlueMountain Capital Management, LLC. 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 (discussed on the Forum here) and Appraisal After Dell, both by Guhan Subramanian.

The frequently discussed but generally unwritten story underlying the three judicial opinions in Verition Partners v. Aruba Networks involves a dispute between two luminaries of the Delaware Corporate Law—Vice Chancellor Travis Laster and Chief Justice Leo Strine.

The story goes that Vice Chancellor Laster, fuming over his “rebuke” in Dell, a decision not written but generally attributed to the Chief Justice, sought to force acknowledgement of the faults in that decision by adopting an extreme view of its logic and interpreting it reductio ad absurdum for a “result that no litigant would even ask for”. He did so by (i) finding an odious transaction process involving rampant conflicts of interest, negotiating negligence and selective disclosure to be sufficiently reliable to evidence fair value (“FV”) because its record of defects was, in his view, no worse than the one in Dell, while, nevertheless, (ii) ruling that the cleanest measure of FV was the Company’s so-called unaffected stock price (“USP”), a metric that was neither argued by any party at trial nor particularly well suited to the FV measurement objective, given strong evidence of conflicts of interest and the exploitation of material non-public information found in the trial record. Similar to the first holding, on process sufficiency (or what was subsequently coined by Vice Chancellor Glasscock as “Dell Compliance” in AOL), the latter holding on “USP Relevance” was grounded in the Vice Chancellor’s comparison of the factual record of Aruba against those in Dell and DFC, and the Delaware Supreme Court’s heavy deference to observable market measures of value in those cases. Not to be outdone by this deft, “hoisted on your own petard” tactic by the Vice Chancellor, the Chief Justice returned the favor in a manner that only a superior tribunal can—by (a) reversing the Chancery Court on the USP Relevance holding via a scathing criticism of its reductionist argumentation, (b) affirming its Dell Compliance holding with virtually no discussion on the merits of the Chancery Court’s adjudication of that issue, and (c) directing a verdict in reliance on the Dell Compliance holding—notwithstanding obvious conflicts in the trial record on the quantification of deductible synergies that, absent judicial gloss, would have frustrated such implementation. While motives remain opaque, the twin effects of this directed verdict are to establish finality (i.e., ensure there will be no Aruba IV or, more importantly, Aruba V) and, by implication, to set in stone the Vice Chancellor’s findings of fact that implicitly sanction as “reliable” a very, very dirty deal.


Precluding Pre-Merger Communications in Post-Merger Dispute

John Mark Zeberkiewicz is director and Daniel E. Kaprow is an associate at Richards, Layton & Finger, P.A. This post is based on a Richards Layton memorandum by Messrs. Zeberkiewicz, Kaprow, Rudolf Koch and Robert Greco, 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 Allocating Risk Through Contract: Evidence from M&A and Policy Implications (discussed on the Forum here); and M&A Contracts: Purposes, Types, Regulation, and Patterns of Practice, both by John C. Coates, IV.

In Shareholder Representative Services LLC v. RSI Holdco, LLC, C.A. No. 2018-0517-KSJM (Del. Ch. May 29, 2019), the Delaware Court of Chancery upheld a provision in a private-company merger agreement precluding a buyer from using the seller’s privileged emails against the seller in post-closing litigation. Following the guidance from the decision in Great Hill Equity Partners IV, LP v. SIG Growth Equity Fund I, LLLP, 80 A.3d 155 (Del. Ch. 2013), the RSI Court held that under the terms of the parties’ merger agreement, pre-merger communications between the target company’s owners and representatives and the target company’s counsel could not be used by the buyer in a post-closing dispute.

In September 2016, RSI Holdco, LLC (“Buyer”) acquired Radixx Solutions International, Inc. (“Radixx”). Radixx and its counsel negotiated for a so-called “Great Hill provision” in the merger agreement—i.e., one providing that certain pre-merger privileged communications would not pass to the Buyer at the effective time. In essence, the merger agreement provided that the pre-merger privileged communications between the sellers and company counsel would survive the merger and be assigned to the stockholders’ representative, and prevented the Buyer from using or relying on any such privileged communications. Despite the clear language of the merger agreement, the Buyer sought to use approximately 1,200 pre-merger emails that it had acquired by virtue of the merger in post-closing litigation. Although it acknowledged that the emails were presumably privileged at the time they were made, the Buyer argued that because the sellers did not take steps to excise or segregate the privileged communications from the email servers, the privilege had been waived.


The New DOJ Compliance Guidelines and the Board’s Caremark Duties

Michael W. Peregrine is a partner at McDermott Will & Emery LLP. This post is based on his McDermott Will & Emery memorandum. This post is part of the Delaware law series; links to other posts in the series are available here.

Much has been written of late about the significance of the Department of Justice’s new “Evaluation of Corporate Compliance Plan Programs” [1] guidance (“New Guidance”) and its likely impact on the “nuts and bolts” of compliance program design and operation. But the Guidance may have more far-reaching implications to the extent that it serves to revitalize the authority and engagement of the governing board’s “Caremark” compliance oversight function. For at its core, the New Guidance is a strong reminder of the critical role that corporate governance plays in assuring a compliant corporate culture.

The New Guidance

The New Guidance is the latest effort by the Department of Justice to provide clarity and direction on the government’s perspective for measuring compliance program effectiveness. Released on April 30, it updates a prior version issued by the Criminal Division’s Fraud Section in February 2017. It discusses in detail topics the Criminal Division has frequently found relevant in evaluating corporate compliance programs, and organizes the detail around three main questions that prosecutors raise when evaluating such programs: 1) whether the program is well-designed; 2) whether the program has been applied earnestly and in good faith (in other words, effectively implemented); and 3) whether the program actually works in practice. [2]


Is Goldman Sachs’ Director Compensation Entirely Fair?

Audrey Fenske and Steve Quinlivan are partners and Jaclyn Schroeder is an associate at Stinson LLP. This post is based on a Stinson memorandum by Ms. Fenske, Mr. Quinlivan, Ms. Schroeder, Bryan Pitko, Phil McKnight, and Jack Bowling. This post is part of the Delaware law series; links to other posts in the series are available here.

Quoting both a nearly 70-year-old decision and a nearly 30-year-old SNL skit, the Delaware Court of Chancery, in Stein v. Blankfein et al, reaffirmed that in most circumstances decisions of directors awarding director compensation are subject to review under the entire fairness standard. The Court also addressed the possibility of stockholder waiver of application of that standard to future director actions, but did not conclude as to whether such a waiver was even possible. The litigation addressed compensation of Goldman Sachs’ directors—primarily the stock incentive plans, or SIPs, approved by Goldman Sachs stockholders in 2013 and 2015. Ruling on a motion to dismiss, the Court rejected director defendants’ arguments that:

  • the stockholder-approved SIPs absolved, in advance, the director’s breaches of duty in self-dealing, absent a demonstration of bad faith. Since the argument was rejected the director decisions were subject to review under the entire fairness standard because the plans provided the directors discretion to determine their own awards; and
  • the plaintiff failed to adequately allege that the self-awarded director compensation was not entirely fair.

The following courses of action remain available to public company boards in approving director compensation:

  • have specific awards or self-executing guidelines approved by stockholders in advance; or
  • knowing that the entire fairness standard will apply, limit discretion with specific and meaningful limits on awards and approve director compensation with a fully developed record, including where appropriate, incorporating the advice of legal counsel and that of compensation consultants.


Trulia’s Impact

Jason M. Halper is partner, Jared Stanisci is special counsel, and Victor Bieger is an associate at Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader memorandum by Mr. Halper, Mr. Stanisci, Mr. Bieger, Ellen HollomanNathan M. Bull, and Zack Schrieber. This post is part of the Delaware law series; links to other posts in the series are available here.

The Delaware Court of Chancery’s 2016 decision in In re Trulia, Inc. Stockholder Litigation changed the landscape for “disclosure-only” settlements in class action suits. Recognizing a trend that had been building in the Court of Chancery, in Trulia Chancellor Bouchard declared his intent to reject disclosure-only settlements unless the resulting supplemental disclosures are “plainly material” and any releases are “narrowly circumscribed. Based on the most recent data, this has led to a spike in the number of M&A transactions that have been challenged in federal courts.

While there were only 34 cases filed in federal court in 2015 before Trulia, this number increased by fivefold in 2018 with 182 cases filed. Of these challenges, approximately one-third were brought in district courts in the Third Circuit.

Trulia appears to have inspired plaintiffs’ firms to bring challenges to merger transactions in federal and state courts outside of Delaware in the hopes of escaping its effect. But other jurisdictions are divided about whether to follow the Trulia approach. This continuing jurisdictional split is likely to encourage plaintiffs to keep forum shopping in the hopes of striking a quick disclosure-only settlement, and thereby receiving a fee from the target company as part of the settlement while expending relatively little effort.


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