The Delaware Law Series


A Guidebook to Boardroom Governance Issues

Katherine HendersonAmy Simmerman are partners at Wilson Sonsini Goodrich & Rosati. This post is based on a WSGR publication by Ms. Henderson, Ms. Simmerman, Brad Sorrels, Ryan Greecher, David Berger, and Lisa Stimmell.

In recent years, we have seen boards and management increasingly grapple with a recurring set of governance issues in the boardroom. This publication is intended to distill the most prevalent issues in one place and provide our clients with a useful and practical overview of the state of the law and appropriate ways to address complex governance problems. This publication is designed to be valuable both to public and private companies, and various governance issues overlap across those spaces, although certainly some of these issues will take on greater prominence depending on whether a company is public or private. There are other important adjacent topics not covered in this publication—for example, the influence of stockholder activism or the role of proxy advisory firms. Our focus here is on the most sensitive issues that arise internally within the boardroom, to help directors and management run the affairs of the corporation responsibly and limit their own exposure in the process.

The Purpose of the Corporation and the Role of Stakeholders

Corporate purpose, along with the related question of whether and how a board of directors should consider non-stockholder interests—such as environmental, social, and governance (“ESG”) issues—has become a major source of debate among policymakers, lawyers, academics, institutional investors, and even jurists in recent years. This debate challenges the dominance of stockholder primacy ideology, which has effectively constrained corporate boards since at least the mid-1980s.

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Does Trados Matter?

Abraham Cable is Professor of Law at University of California Hastings College of the Law. This post is based on his recent paper, forthcoming in The Journal of Corporation Law. 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 Agency Costs of Venture Capitalist Control in Startups by Jesse Fried and Mira Ganor.

Delaware courts are producing a growing cannon of corporate law recognizing the distinctive business environment of Silicon Valley. Trados is a prominent example. In a recent paper, I ask Silicon Valley lawyers whether the high-profile case actually affects their advice to clients. The answer? A resounding sort of.

In Trados, the Delaware Chancery Court criticized a board controlled by venture capital funds holding preferred stock. The board approved a merger that, in accordance with customary Silicon Valley stock terms, resulted in a modest payout to investors holding preferred stock but no consideration to common shareholders. Though the court ultimately found in favor of the defendant directors, the court sharply criticized the board’s process and lack of regard for common holders. According to the court, the board “did not understand . . . their job,” “refused to recognize the conflicts they faced,” and engaged in a “vigorous and coordinated effort” to “recharacterize their actions retrospectively.” The only saving grace for the board was their expert witness, who convinced the court that the common stock in fact had no substantial value.

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Conflicted Controllers, the “800-Pound Gorillas”: Part II—BGC

Gail Weinstein is senior counsel, and Brian T. Mangino and Andrew J. Colosimo are partners at, Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum authored by Ms. Weinstein, Mr. Mangino, Mr. Colosimo, Steven Epstein, Matthew V. Soran, and Randi Lally, 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).

In the past quarter, two important Court of Chancery decisions—Tornetta and BGC—have highlighted the “reflexive skepticism” with which the Delaware courts approach transactions involving conflicted controllers.

  • In Tornetta, a case of first impression according to the court, Vice Chancellor Slights held that unless a board’s decision on executive compensation for a controlling stockholder-CEO complies with the protections outlined in the seminal MFW decision, the entire fairness standard of review (which is the strictest standard) applies to the court’s evaluation of a stockholder challenge to the compensation. The court so decided notwithstanding that, until now, a) business judgment review has applied to compensation decisions made by independent directors and b) MFW-compliance has been required for business judgment review of conflicted controller transactions only in the context of transactions that are “transformational” for the corporation.
  • In BGC, Chancellor Bouchard applied what seems to be a more stringent standard than in the past for evaluating whether putatively independent directors can be presumed to be capable of acting independently from a controller in the context of evaluating demand (“Demand futility” means that a stockholder who wishes to bring claims against a controller need not first make a demand on the board—for the board to bring the claims on behalf of the corporation—if doing so would be “futile” because the directors’ conflicts or lack of “independence” suggest that they might not be capable of making the decision impartially.) The Chancellor appeared to focus on the sense of owingness that a director could feel toward a controller if the director’s general status or positions of importance in the company or the community were a result of his or her connection with the controller.

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Conflicted Controllers, the “800-Pound Gorillas”: Part I—Tornetta

Gail Weinstein is senior counsel, and Brian T. Mangino and Andrew J. Colosimo are partners at, Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum authored by Ms. Weinstein, Mr. Mangino, Mr. Colosimo, Steven Epstein, Matthew V. Soran, and Randi Lally, 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 Executive Compensation in Controlled Companies by Kobi Kastiel (discussed on the Forum here).

In the past quarter, two important Court of Chancery decisions—Tornetta and BGC—have highlighted the “reflexive skepticism” with which the Delaware courts approach transactions involving conflicted controllers.

  • In Tornetta, a case of first impression according to the court, Vice Chancellor Slights held that unless a board’s decision on executive compensation for a controlling stockholder–CEO complies with the protections outlined in the seminal MFW decision, the entire fairness standard of review (which is the strictest standard) applies to the court’s evaluation of a stockholder challenge to the compensation. The court so decided notwithstanding that, until now, a) business judgment review has applied to compensation decisions made by independent directors and b) MFW-compliance has been required for business judgment review of conflicted controller transactions only in the context of transactions that are “transformational” for the corporation.

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The Corrosion Critique of Benefit Corporations

Brett McDonnell is the Dorsey & Whitney Chair in Law at the University of Minnesota Law School. This post is based on his recent paper, and is part of the Delaware law series; links to other posts in the series are available here.

Benefit corporation statutes have emerged as the leading new statutory alternative to enable and encourage social enterprises, businesses which seek both to generate financial returns for their investors while also pursuing social missions. Some persons who strongly support social enterprises have criticized benefit corporation statutes, arguing that they create a mistaken impression that companies organized under ordinary corporation statutes cannot consider the interests of non-shareholder stakeholders except insofar as doing so benefits shareholders in the long run. This corrosive effect on the understanding of most corporations may impede the adoption of socially responsible behavior. I call this common criticism of benefit corporation statutes the “corrosion critique.”

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Outlaws of the Roundtable? Adopting a Long-term Value Bylaw

Neil Whoriskey is partner at Cleary Gottlieb Steen & Hamilton LLP. This post is based on a Cleary Gottlieb memorandum by Mr. Whoriskey. Related research from the Program on Corporate Governance includes Can We Do Better by Ordinary Investors? A Pragmatic Reaction to the Dueling Ideological Mythologists of Corporate Law by Leo E. Strine (discussed on the Forum here) and The Myth that Insulating Boards Serves Long-Term Value by Lucian Bebchuk (discussed on the Forum here).

The CEOs of 150 major US public companies recently pledged to act for all of their “stakeholders”—customers, employees, suppliers, communities and yes, even stockholders. [1] Much commentary ensued. But before we get too excited about whether these CEOs are grasping the mantle of government to act on behalf of the citizenry and other people who aren’t paying them, there is the prior question of whether, as a matter of Delaware law, they can.

Under Delaware law, directors owe a fundamental duty of loyalty—the question is, to whom? There has been some academic debate over the years as to whether this duty is owed exclusively to stockholders or is also owed to other stakeholders of the corporation, but the weight of decided Delaware law comes down firmly on the side of stockholders. [2] The Delaware Supreme Court ruled 30 years ago that the interests of other stakeholders may be considered only if “there are rationally related benefits accruing to the stockholders.” [3] The current Chief Justice of the Delaware Supreme Court echoed this view: “[T]he object of the corporation is to produce profits for the stockholders. . . [T]he social beliefs of the manager, no more than their own financial interests, cannot be their end in managing the corporation.” [4] In other words, the duty of loyalty requires that the corporation be run for the benefit of stockholders—a predictable result, as the Chief Justice points out, in a governance system that in all its particulars is based on the “relationship between corporate managers and stockholders. . . where only stockholders get to vote and only stockholders get to sue to enforce directors’ fiduciary duties.” [5]

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The Passing of Retired Chancellor William T. Allen

Leo E. Strine, Jr. is Chief Justice of the Delaware Supreme Court, the Austin Wakeman Scott Lecturer on Law and a Senior Fellow of the Harvard Law School Program on Corporate Governance.

The Delaware Judiciary was saddened to learn of the passing on Sunday of retired Chancellor William T. Allen, a giant of the corporate bar, academia, and the Delaware Bench. The Judiciary expresses its deepest condolences to the friends and family of Chancellor Allen.

Allen, 75, was appointed as Chancellor of the Delaware Court of Chancery by Governor Mike Castle in 1985. He served until 1997 when he returned to his alma mater, New York University, to teach law and re-entered private practice at Wachtell, Lipton, Rosen & Katz.

“Our nation lost one of the finest jurists of the last fifty years yesterday,” said Delaware Supreme Court Chief Justice Leo E. Strine, Jr. “Chancellor Allen set a standard of excellence that made Delaware stand out in the eyes of all sophisticated observers. Bill Allen, the person, set a standard as a husband, father, friend, and caring professor to which we should all aspire. For me personally, he was a mentor, source of wisdom, and an inspiration. Everyone in Delaware owes him a debt of gratitude for what he did for our state, and our Judiciary’s hearts are with his wife and children, as they endure the loss of this special man.”

“I was saddened on Sunday to learn of the passing of former Chancellor Allen—one of Delaware’s finest legal minds,” said Delaware Governor John Carney. “Bill helped set and maintain a reputation of excellence on Delaware’s Court of Chancery. He was known and respected across our country, and by many citizens in our state, for his judgment and his fairness. My thoughts and prayers remain with Bill’s family and his many friends during this difficult time,” he said.

William T. Allen became Chancellor in 1985, at a time when the takeover boom of the 1980s was in full swing and the Delaware Court of Chancery was the subject of intense national scrutiny. During that time, Chancellor Allen’s decisions, often produced under extreme time pressure, were known for their lucid and lively writing style and incisive analysis. His rulings also showed a deep concern for the integrity of the law, the need for those with power to use it with fidelity to those they represented, and for their understanding of scholarship relevant to the matters before the Court. For that reason, Chancellor Allen was considered to be one of the finest corporate law judges of the era and, even more broadly, as one of the finest judges of his generation on any court. When Delaware most needed a Chancellor that could provide trusted corporate law rulings that all would respect, it was fortunate to have Bill Allen in that critical position.

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Observations on Clovis Oncology, Inc. Derivative Litigation

Peter J. Walsh, Jr. is a partner, and Nicholas D. Mozal is counsel, at Potter Anderson & Corroon LLP. This post is based on their Potter Anderson memorandum and is part of the Delaware law series; links to other posts in the series are available here.

On October 1, the Delaware Court of Chancery denied a motion to dismiss a Caremark claim in In re Clovis Oncology, Inc. Derivative Litigation. Under In re Caremark Int’l Inc. Deriv. Litig., 698 A.2d 959 (Del. Ch. 1996), directors have a duty to exercise oversight and monitor a corporation’s operational viability, legal compliance, and financial performance. Clovis is the first decision to allow a Caremark claim to proceed beyond the pleadings since the Delaware Supreme Court’s June 2019 decision in Marchand v. Barnhill, which reversed a Court of Chancery decision dismissing a Caremark claim. The Clovis decision highlights (i) the importance of board level efforts to oversee compliance with governing law and regulatory mandates, particularly in situations where compliance issues are critical to a “monoline” company, and (ii) how stockholders are using books and records demands under 8 Del. C. § 220 to pursue fiduciary claims focused on those same compliance issues.

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Delaware Choice-of-Law Provisions in Restrictive Covenant Agreements

Christopher B. Chuff is an associate at Pepper Hamilton LLP. This post is based on a Pepper memorandum by Mr. Chuff, Joanna J. Cline, Matthew M. Greenberg, and Taylor B. Bartholomew. This post is part of the Delaware law series; links to other posts in the series are available here.

It is well-settled that California has a strong public policy against the enforcement of restrictive covenants against employees. Because of this, there has been a recent trend where employers have sought to circumvent California’s public policy by invoking Delaware law in restrictive covenant agreements with their employees. However, in a number of recent opinions, the Delaware Court of Chancery has resisted those efforts, instead choosing to invalidate the Delaware choice-of-law provisions and apply California law to void the restrictive covenants.

Indeed, despite the fact that Delaware is typically a contractarian state, the Court of Chancery has reasoned that, unless one or more conditions (summarized below) are met, California-based companies will not be permitted to effectuate an end run around California’s strict public policy by invoking Delaware law in contracts with their employees. Furthermore, although not directly addressed by the Court of Chancery’s recent decisions, it is likely, based on the Court’s reasoning in these decisions, that Delaware courts will apply California law to void noncompetition and nonsolicitation provisions within an agreement between employers with their principal places of business outside of California and their employees that live and work primarily in California, notwithstanding the existence of a Delaware choice-of-law provision.

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Clear and Unambiguous Terms of Merger Agreement

Jason M. Halper is partner, Jared Stanisci is special counsel, and Sara Bussiere is an associate at Cadwalader, Wickersham & Taft LLP. This post is based on a Cadwalader memorandum by Mr. Halper, Mr. Stanisci, Ms. Bussiere, William Mills, Nathan Bull, and Audrey Curtis 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 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.

The Delaware Court of Chancery’s recent decision, Genuine Parts Company v. Essendant Inc., [1] provides a helpful reminder that Delaware courts will enforce the clear and unambiguous terms of a merger agreement, and will consider contractual interpretation issues on a motion to dismiss when it finds the contractual terms to be clear and unambiguous. In Essendant, the Court denied the defendant’s motion to dismiss and found that: (i) Genuine Parts Company (“GPC”) adequately pled that the termination fee in the merger agreement was not the exclusive remedy for termination or a breach of the agreement; (ii) GPC did not waive its breach of contract claim by accepting the termination fee; and (iii) GPC pled sufficient facts to support a reasonably conceivable claim that the exclusivity provision in the merger agreement between the parties was a material term of the agreement which could be the basis for a breach of contract claim. This decision once again reinforces the need for parties to be mindful when negotiating and drafting a contract that contractual provisions reflect their understanding of the agreements they have made in the event of a breach or termination of the agreement. [2] In particular, Essendant cautions that contracting parties who want to limit recovery to the terms of the termination fee provision should carefully craft broad termination fee provisions that clearly and unambiguously state the parties’ intentions. Essendant also serves as a further reminder that a contractual party’s acceptance of a termination fee, absent specific contractual language to the contrary, will not preclude that party from pursuing a breach of contract claim. READ MORE »

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