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Program on Corporate Governance Advisory Board
- William Ackman
- Peter Atkins
- David Bell
- Kerry E. Berchem
- Richard Brand
- Daniel Burch
- Paul Choi
- Jesse Cohn
- Creighton Condon
- Arthur B. Crozier
- Renata J. Ferrari
- John Finley
- Carolyn Frantz
- Bruce H. Goldfarb
- Joseph Hall
- Jason M. Halper
- Paul Hilal
- Carl Icahn
- David Millstone
- Theodore Mirvis
- Maria Moats
- Erika Moore
- Carey Oven
- Morton Pierce
- Philip Richter
- Paul K. Rowe
- Marc Trevino
- Steven J. Williams
- Daniel Wolf
HLS Faculty & Senior Fellows
The Delaware Law Series
Proceduralism: Delaware’s Legacy
Dalia Tsuk Mitchell is The John Marshall Harlan Dean’s Research Professor of Law at George Washington University Law School. This post is based on her recent article published in the University of Chicago Business Law Review, and is part of the Delaware law series; links to other posts in the series are available here.
The 1980s were a watershed moment in the history of corporate law. In a series of decisions addressing the board of directors’ duties in friendly mergers and hostile takeovers, the Delaware Supreme Court seemed to depart from its historical deference to directors’ discretion and instead subjected directors’ actions to judicial review. In Smith v. Van Gorkom (1985), the Court held that the highly experienced and long-tenured directors of Trans Union were grossly negligent when they approved a merger agreement, even though the merger provided Trans Union’s shareholders with an almost 50% premium over the market price of the stock. Less than six months later, in Unocal Corp. v. Mesa Petroleum Corp. (1985), the Court held that a target board must demonstrate that a threat to corporate policy existed and that its actions were reasonable given the nature of the threat to justify defensive measures. Shortly thereafter, in Revlon, Inc. v. MacAndrews & Forbes Holdings (1986), the Court declared that a company’s board must strive to ensure that the shareholders receive best price if it decides to allow the sale of the company. In all, the Delaware Supreme Court’s willingness to subject directors’ decisions to review and insist on fair or best price for the shareholders seemed to deviate from Delaware’s historical deference to directors’ business judgment. As Martin Lipton pointedly charged at the time, “Delaware has misled corporate America . . . It lured companies in with a promise that the business judgment rule would govern corporate law. It’s obvious that the state has reneged” (quoted in William Meyers, Showdown in Delaware: The Battle to Shape Takeover Law, Institutional Investor, Feb. 1989, at 75).
Many have since argued that the 1980s marked the end of managerialism (the idea that expert managers could be trusted to lead corporations as they deemed beneficial for all corporate stakeholders) and the birth of shareholder valuism (the notion that corporations should maximize value only to the shareholders) as corporate law’s normative anchor. As Karen Ho writes, the 1980s blitz of hostile takeovers was a means to an end, namely removing the “elite, complacent, and self-serving managerial class” that has presumably “squandered corporate resources extravagantly on themselves or on ill-advised expansions” and “unlocking the value of ‘underperforming’ stock prices” to the benefit of the shareholders (Karen Ho, Liquidated: An Ethnography of Wall Street 130 (2009)).
Trend in Delaware Merits Heightened Attention by Acquirors
Ethan Klingsberg is a Partner and Victor Ma is an Associate at Freshfields Bruckhaus Deringer LLP. This post is based on their Freshfields 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 Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? (discussed on the Forum here) by John C. Coates, Darius Palia, and Ge Wu; and The New Look of Deal Protection (discussed on the Forum here) by Fernan Restrepo and Guhan Subramanian.
A trio of recent, high-profile M&A cases in the Delaware Court of Chancery merit special attention by M&A acquirors. In each of these cases, the Court highlighted the liability of the third-party acquiror of a publicly listed target company for aiding and abetting breaches of fiduciary duties by the target board and executives. [1]
Historically, successful “aiding and abetting” claims have been limited to the advisors of target companies and affiliates of a director. [2] However, there are a number of reasons why asserting aiding and abetting claims against third-party buyers may now be attractive for plaintiffs in light of these recent cases:
- An aider and abettor will have joint and several liability for the underlying fiduciary duty breach by the target board or executive team in a sale process. This means another deep pocket from which to obtain funds and have leverage in settlement discussions. The Delaware Court of Chancery will often determine damages by looking to the difference between what the aggregate merger consideration would have been, but for the breach of duty, and the actual merger consideration. Under this approach, the aggregate damages can be in the hundreds of millions of dollars and therefore having multiple deep pockets to draw from is of real value to the plaintiffs.
- In the case of breaches of the duty of care (such as a shortfall in the performance of Revlon duties to obtain the best price reasonably available in a sale process), many claims for damages against target company directors and officers are nullified by the applicability of the right to exculpation as permitted by Section 102(b)(7) of the Delaware General Corporation Law. [3] But claims against an aiding and abetting third-party buyer are not entitled to any such exculpation.
- As an aiding and abetting defendant, the acquiror becomes subject to potentially enhanced discovery of internal documents and depositions. It is even possible that the acquiror’s own stockholders will start to pursue books and records demands and even derivative claims against the acquiror’s board relating to the aiding and abetting activity. These risks provide further leverage for the plaintiffs to induce an early settlement payment directly from the acquiror.
- Troublingly, the standard insurance policies of many strategic acquirors—especially those that are publicly listed—may not currently cover these aiding and abetting liability risks. This vulnerability may further induce these acquirors to settle quickly rather than fight an aiding and abetting claim.
Lessons from the 2023 Proxy Season: Advance Notice Bylaws and Officer Exculpation
Douglas K. Schnell is a Partner and Daniyal M. Iqbal is an Associate at Wilson Sonsini Goodrich & Rosati. This post is based on a WSGR memorandum by Mr. Schnell, Mr. Iqbal, Amy L. Simmerman, Ryan J. Greecher and Brad Sorrels.
With the 2023 proxy season now over for most companies, we took a fresh look at recent bylaw and charter amendments at the Silicon Valley 150 (the SV150) to better understand how companies are addressing i) new Rule 14a-19, which mandates the use of a universal proxy card in contested elections; and ii) the recent amendment to Section 102(b)(7) of the Delaware General Corporation Law (DGCL) to permit the adoption of officer exculpation charter provisions.
I. Bylaw Amendments Following the Adoption of Universal Proxy
As discussed in our prior Client Alert, the 2023 proxy season was the first following the adoption of Rule 14a-19. Generally speaking, these rules require proxy cards distributed in connection with a contested director election to include all director candidates, whether nominated by the company or by shareholders. In this way, shareholders can “mix and match” between the members of competing director slates.
Following the adoption of Rule 14a-19, many companies amended their advance notice bylaws to account for the universal proxy rules. More specifically, of the 70 companies in the SV150 that amended their bylaws between November 1, 2021, and July 31, 2023, 50 amended their bylaws explicitly to address Rule 14a-19, with 90 percent of those amendments occurring after the August 31, 2022, effective date of Rule 14a-19. We refer to these 50 companies as the “Specifically Address Group.” In examining these amendments, a few trends stood out.
Recent Delaware Law Amendments Could Impact Shareholder Meetings
Subodh Mishra is Global Head of Communications at Institutional Shareholder Services (ISS) Inc. This post is based on an ISS memorandum by Marc Goldstein, Head of U.S. Governance Research at Institutional Shareholder Services, is part of the Delaware law series; links to other posts in the series are available here.
Several changes to the Delaware General Corporation Law (DGCL) took effect on August 1, 2023. While perhaps less significant than the 2022 amendments to the DGCL and Delaware Statutory Trust Act, which permitted exculpation of executive officers for violations of the duty of care and mandated that Delaware closed-end mutual funds be covered by a control share acquisition statute, respectively, a few of the 2023 changes are likely to have an impact on shareholder meetings in 2024 and beyond.
The most important amendments this year are to the vote requirements for forward and reverse stock splits. Going forward, Delaware companies will not be required to seek shareholder approval for any forward stock split, as long as the class of stock being split is the only class issued by the company. Reverse stock splits and increases or decreases in the number of authorized shares will now require approval by a majority of votes cast, rather than a majority of shares outstanding; provided that the class of stock in question is listed on a national securities exchange and the company would continue to meet listing requirements as to the minimum number of holders following the reverse split. Companies can choose to maintain the higher vote standards if they affirmatively opt out of the new provisions by specifying in the charter that forward or reverse splits require approval by a majority of outstanding shares.
Forward stock splits are typically carried out by relatively large companies, which tend to have high levels of institutional ownership, and such companies rarely have difficulty in obtaining approval for a forward split. By contrast, reverse stock splits are most often employed by microcap companies as a way to raise the share price and thereby avoid delisting for failure to meet the stock exchange minimum bid price requirement. Despite the obvious benefits to shareholders of maintaining the company’s listing, and the lack of any significant active opposition to a reverse split proposal, many such companies have struggled to obtain the necessary approval, due to low turnout by retail investors that has prevented them from garnering the affirmative vote of a majority of the voting power of outstanding shares. Over the past year and a half, more than 50 such companies – mostly incorporated in Delaware – have issued preferred shares with enhanced voting rights applicable only to a reverse split proposal, as a way to clear the hurdle imposed by the previous vote standard. Such workarounds should no longer be necessary at Delaware companies thanks to the change in the vote requirement.
New Ruling Highlights Unintended Consequences of Excluding Officers from Fiduciary Duty Waivers
Benet J. O’Reilly is a Partner and Lina Dayem is an Associate at Cleary Gottlieb Steen & Hamilton LLP. This post is based on their Cleary memorandum and is part of the Delaware law series; links to other posts in the series are available here.
Delaware law provides parties with significant flexibility to restrict or eliminate fiduciary duties in LLC agreements. Sophisticated parties regularly take advantage of this flexibility by eliminating fiduciary duties of members and directors of LLCs. These same parties, however, often choose not to extend these waivers to officers of the LLCs, often stemming from a desire to ensure that officers still have a fiduciary duty to be loyal to the LLC. A new ruling from the Delaware Court of Chancery highlights the unintended consequences of excluding officers from the scope of the fiduciary duty waiver.
In Cygnus Opportunity Fund, LLC, et al. v. Washington Prime Group, LLC, et al., [1] the Court denied dismissal of claims alleging that company officers breached their fiduciary duties by failing to provide adequate information to minority investors in connection with a tender offer by the controlling member and a subsequent squeeze-out merger. In addition, the Court allowed the survival of claims against the officers, the board and the controlling investor, asserting a breach of the covenant of good faith in connection with the transactions.
Cygnus illuminates two key tensions (also examined here, here, and here): (i) the tension between the officers’ duties owed to the board of managers versus its fiduciary duties owed to the members and (ii) the tension between freedom of contract when drafting LLC agreements versus the backstop of the implied covenant of good faith and fair dealing. These facts are worth keeping in mind when drafting LLC agreements with fiduciary duty waivers and provisions that grant full discretion to one of the parties. Below we break down the Court’s analysis and key takeaways.
Special Committee Report
Gregory V. Gooding and Maeve O’Connor are Partners and Caitlin Gibson is a Counsel at Debevoise & Plimpton LLP. This post is based on a Debevoise memorandum by Mr. Gooding, Ms. O’Connor, Ms. Gibson, Andrew Bab, Bill Regner, and Matthew Ryan, and is part of the Delaware law series; links to other posts in the series are available here.
This post surveys corporate transactions announced during the first half of 2023 that used special committees to manage conflicts and key Delaware judicial decisions during this period ruling on issues relating to the use of special committees.
Who Controls and When?
Delaware courts have held that transactions between a controlled company and its controller are subject to the test of entire fairness—Delaware’s most exacting standard of review—due to the inherent risk of minority stockholder abuse presented by such transactions. In structuring a transaction between a Delaware company and a significant stockholder—or a transaction in which a significant stockholder has interests that differ from those of other stockholders—the first step is to determine whether that significant stockholder controls the company, either generally or with respect to the specific transaction being considered.
In some cases, the answer is clear. A stockholder owning more than 50% of a company’s voting power controls that company. In the case of a public company, ownership of somewhat less than 50% can result in control given the practical reality that less than 100% of the shares will be present at any stockholder meeting, with the result that the near majority stockholder will be able to elect the entire board. But the controller status of a stockholder owning a significant, but meaningfully less than majority, equity interest occupies a more uncertain status. While Delaware courts have found control potentially to exist at levels well below 50% ownership, proving control in those circumstances requires the plaintiff to demonstrate that the alleged controller has actually dominated the company’s conduct, either generally or with respect to the particular transaction being challenged. The existence of such control is a “highly contextualized” question, depending not only on share ownership but also on a variety of other factors, [1] none of which alone may be sufficient to prove control. Rather, “[a] finding of control . . . typically results when a confluence of multiple sources combines in a fact-specific manner to produce a particular result,” [2] as illustrated by the examples below.
Upwards of $400 Million in Damages for Aiding and Abetting Claim Against Acquiror
Michael S. Darby and Rick S. Horvath are Partners, and Matthew F. Williams is an Associate at Dechert LLP. This post is based on their Dechert 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 Are M&A Contract Clauses Value Relevant to Target and Bidder Shareholders? (discussed on the Forum here) by John C. Coates, IV, Darius Palia, and Ge Wu; and The New Look of Deal Protection (discussed on the Forum here) by Fernan Restrepo, and Guhan Subramanian.
Key Takeaways
- The Delaware Court of Chancery awarded US$1 per share in damages against an acquiror that knew of, and exploited, conflicts on the selling company’s management team.
- The Court also awarded damages against the acquiror for failing to insist that the target’s proxy statement disclose details about flaws in the sale process.
- Going forward, the Court eliminates the need for stockholder-plaintiffs to prove that stockholders relied on material misrepresentations and omissions in a request for stockholder action, and instead will require defendants to rebut a presumption of stockholder reliance.
Bringing an End to “Derivative” Section 14(a) Claims
Mark E. McDonald and Roger A. Cooper are Partners at Cleary Gottlieb Steen & Hamilton LLP. This post is based on their Cleary memorandum and is part of the Delaware law series; links to other posts in the series are available here.
Much has been written lately about a circuit split on the question whether a company’s forum selection bylaw mandating shareholder derivative lawsuits be brought in Delaware state court trumps a federal lawsuit asserting a derivative claim under Section 14(a) of the Securities Exchange Act of 1934 (which can only be asserted – if at all – in federal court). The Seventh Circuit answered this question “no” [1] while the Ninth Circuit sitting en banc answered “yes,” [2] in both cases over vigorous dissents. Many have speculated that the U.S. Supreme Court may weigh in to resolve this clear circuit split.
Regardless of whether the Supreme Court agrees to weigh in on the forum selection bylaw issue, however, there is a more direct path for public company boards to obtain dismissal of derivative Section 14(a) claims. This path does not depend on enforcement of a forum selection bylaw (which not all public companies have) and thus does not directly implicate the policy considerations that have animated the split between the Seventh and Ninth Circuits. But this path has so far been underutilized by the defense bar, despite a proliferation of cases filed in federal court seeking to assert derivative Section 14(a) claims against public company boards (in some cases successfully extracting significant settlements from the defendants). [3]
Delaware Supreme Court Upholds Board Action that Has a Disenfranchising Effect on a Stockholder
Gail Weinstein is Senior Counsel, Philip Richter and Michael P. Sternheim are Partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Richter, Mr. Sternheim, Steven Epstein, Brian T. Mangino, Amber Banks, and is part of the Delaware law series; links to other posts in the series are available here.
Coster v. UIP (June 28, 2023) is the first decision (so far as we know) in which a Delaware court, in the context of a contested board election, has validated a board of directors’ action that had the effect of disenfranchising a stockholder. Notably, the case presented a highly unusual factual setting. In the decision, the Delaware Supreme Court addressed the overlapping applicability of the Schnell, Blasius and Unocal standards in this context and, combining these doctrines, established a unitary standard for review of board actions that have a disenfranchising effect.
Key Points
- The new standard appears to be, essentially, a heightened Unocal standard. Under the new standard, a board action that has the effect of disenfranchising a stockholder in the face of a contested director election or stockholder vote touching on board control is permissible if it is a “reasonable and proportionate” response to a threat to the corporation (the Unocal standard), but the court will apply the “special sensitivity” toward stockholder disenfranchisement issues that the Schnell and Blasius doctrines bring. The decision furthers the Delaware courts’ longstanding trend of blending these doctrines, with the effect, clarified in UIP, of essentially relegating Schnell and Blasius to being specific applications of the Unocal standard rather than being standards of review themselves.
- In our view, there will still be a very high bar to judicial validation of board action that has the effect of disenfranchising a stockholder in the face of a contested director election or stockholder voting touching on board control. The standard of review the Supreme Court articulated in UIP may appear to be less stringent than the Schnell and Blasius standards that have often been applied in this context. However, we believe it likely that the new standard will not significantly change the court’s general approach to or outcome in these cases—first, because the decision just reaffirms the court’s evolution toward a combination of the Schnell, Blasius and Unocal doctrines in this context; and, second, because, as the Supreme Court emphasized, the facts in UIP were highly unusual.