The Delaware Law Series


Director Nominations and Overbroad Questionnaires

Steve WoloskyAndrew Freedman, and Lori Marks-Esterman are partners at Olshan Frome Wolosky LLP. This post is based on an Olshan memorandum by Mr. Wolosky, Mr. Freedman, and Ms. Marks-Esterman, Ron S. Berenblat, and Kyle J. Kolb. This post is part of the Delaware law series; links to other posts in the series are available here.

On June 27, 2019, the Delaware Chancery Court entered an injunction requiring the boards of trustees (the “Boards”) of two closed-end investment funds (the “Funds”) to count the votes in favor of director candidates nominated by shareholder Saba Capital at the annual meetings scheduled for July 8, 2019. In the case captioned Saba Capital Master Fund, Ltd. v. BlackRock Credit Allocation Income Trust, et al., C.A. No. 2019-0416-MTZ, 2019 WL 2711281 (Del. Ch. Jun 27, 2019), Vice Chancellor Zurn granted Saba Capital’s request for injunctive relief, finding that the Funds’ rejection of the nominations submitted by Saba Capital violated the Funds’ bylaws. The Court’s ruling is consistent with views recently expressed by Olshan that overzealous defense advisors continue to “cross the line” by using onerous, overbroad questionnaires as traps to thwart shareholder nominations and chill activist campaigns.

Saba Capital had timely given notice of its nominations in compliance with the Funds’ advance notification bylaws. In a response weeks later, the Funds asked that the nominees complete a supplemental questionnaire, which had “nearly one hundred questions over forty-seven pages, and was due in five business days.” The Funds declared the nominations invalid after Saba Capital missed the five-day deadline for submitting the questionnaires (although Saba Capital eventually provided the completed questionnaires).

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Statement on Retirement of Chief Justice Strine

Jay Clayton is Chairman of the U.S. Securities and Exchange Commission. This post is based on Chairman Clayton’s recent statement, available here. The views expressed in this post are those of Mr. Clayton and do not necessarily reflect those of the Securities and Exchange Commission or its staff. Leo Strine, Chief Justice of the Delaware Supreme Court, is a Senior Fellow of the Harvard Law School Program on Corporate Governance. Posts about his recent studies issued by the Program are available here, here, and here.

Yesterday, Chief Justice Leo Strine announced his retirement after more than twenty years on the Delaware Court of Chancery and Supreme Court of Delaware, two of the most important courts for our markets and our investors.

Chief Justice Strine deserves our thanks for bringing his unparalleled combination of energy, intellect, experience, legal knowledge and pragmatism to the bench. His contributions have extended well beyond the courtroom and the Commission has benefited substantially from his willingness to engage with us on a range of topics important to our investors and our markets. Finally, and critical to the work of the SEC, it is clear to me that the interests of our Main Street investors have always been at the front of Chief Justice Strine’s mind.

Thank you for your service Chief Justice Strine.

Fiduciary Violations in Sale of Company

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

On June 21, 2019, Vice Chancellor Kathaleen S. McCormick of the Delaware Court of Chancery issued an opinion addressing a number of significant issues relating to the proper conduct of an M&A process. [1] In denying all defendants’ motions to dismiss, the court first held that the selling company had failed to disclose certain material information to stockholders in seeking their approval of the deal, and as a result, the deferential standard of review set forth by the Delaware Supreme Court in Corwin did not apply to the transaction. As described in more detail below, the court further held, for purposes of a motion to dismiss, that the stockholder plaintiff adequately had alleged that the board breached its fiduciary duty of loyalty in managing various aspects of the sale process. The court also refused to dismiss the plaintiff’s aiding and abetting and civil conspiracy claims against the selling company’s longtime financial advisor that was also its largest stockholder, as well as against the acquiror of the company. The case provides a valuable reminder about potential pitfalls in M&A events and areas of potential risk in resulting stockholder litigation.

The Decision

The various claims in this case are based on a core set of allegations arising out of the plaintiff’s second amended complaint. Those allegations included the following:

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Caremark Liability for Regulatory Compliance Oversight

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

In Marchand v. Barnhill (“Blue Bell”) (June 18, 2019), the plaintiff-stockholder claimed that the directors of Blue Bell Creameries USA, Inc., an ice cream manufacturer (the “Company”), breached their fiduciary duty of loyalty under Caremark by having failed to oversee and monitor the Company’s food safety operations. The suit was brought after an outbreak of listeria contamination in the Company’s ice cream led to the sickening and (in three cases) the death of consumers who ate the ice cream—as well as the recall of all of the Company’s products, the shuttering of all of the Company’s plants, and, ultimately, a liquidity crisis that led the Company to accept a dilutive private equity deal.

Caremark claims” are claims that directors breached the fiduciary duty of loyalty by not making “a good faith effort to oversee the company’s operations.” These claims, which if successful can result in personal liability for directors, are known to be (as the Supreme Court reiterated in Blue Bell) “among the most difficult of corporate claims” to pursue successfully—because a required element of a claim for breach of the duty of loyalty is “bad faith” (i.e., intentional wrongdoing) by directors. Caremark established that, with respect to a board’s oversight obligation, only a “sustained or systematic failure of the board to exercise oversight—such as an utter failure to attempt to assure a reasonable information and reporting system exists—will establish the lack of good faith that is a necessary condition to [personal] liability [of directors].”

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Director Independence and Oversight Obligation in Marchand v. Barnhill

Peter Atkins and Paul Lockwood are partners at Skadden, Arps, Slate, Meagher & Flom LLP. This post is based on their Skadden memorandum and is part of the Delaware law series; links to other posts in the series are available here.

On June 18, 2019, in Marchand v. Barnhill, the Delaware Supreme Court, in an opinion written by Chief Justice Leo E. Strine, Jr. on behalf of a unanimous court, issued a decision reversing the Court of Chancery’s dismissal of a stockholder derivative suit alleging Caremark claims [1]—that the board failed to provide adequate oversight of a key risk area and thus breached its duty of loyalty. The case arose out of a listeria outbreak in ice cream made by Blue Bell Creameries USA Inc. that sickened many consumers, caused three deaths and resulted in a total product recall.

Key Determinations

The key Delaware Supreme Court determinations, both fact-driven, were:

  • Independence. The Supreme Court held that one director, viewed by the Court of Chancery as independent, was not independent based on the allegations in the complaint. As a result, the court found that a majority of the board was not independent and disinterested for purposes of the board’s consideration of a stockholder demand to file a lawsuit against directors and officers.
  • Oversight. For purposes of denying a motion to dismiss by the company, the facts alleged by the plaintiffs were sufficient to satisfy the high Caremark standard for establishing that a board breached its duty of loyalty by failing to make a good faith effort to oversee a material risk area, thus demonstrating bad faith.

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Spotlight on Boards

Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisitions and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton memorandum by Mr. Lipton and is part of the Delaware law series; links to other posts in the series are available here.

The ever-evolving challenges facing corporate boards prompt periodic updates to a snapshot of what is expected from the board of directors of a major public company—not just the legal rules, or the principles published by institutional investors and various corporate and investor associations, but also the aspirational “best practices” that have come to have equivalent influence on board and company behavior. A very significant June decision by the Delaware Supreme Court interpreting the Caremark doctrine that limits director liability for an oversight failure to “utter failure to attempt to assure a reasonable information and reporting system exists” prompts this update. Our memo discussing the decision is available here. The Court said to “satisfy their duty of loyalty,” “directors must make a good faith effort to implement an oversight system and then monitor it” themselves.  Without more, the existence of management-level compliance programs is not enough for the directors to avoid Caremark exposure. Today, boards are expected to:

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The Standard of Review for Challenged Director Compensation

Amy Simmerman and John Aguirre are partners at Wilson Sonsini Goodrich & Rosati. This post is based on a Wilson Sonsini memorandum by Ms. Simmerman, Mr. Aguirre, Boris Feldman, Brad Sorrels, Ryan Greecher, and Lori Will. This post is part of the Delaware law series; links to other posts in the series are available here.

On May 31, 2019, Vice Chancellor Sam Glasscock of the Delaware Court of Chancery issued a decision refusing to dismiss a stockholder’s fiduciary duty claims challenging the compensation of Goldman Sachs’ board of directors. [1] The case highlights the type of claim potentially available to stockholders in challenging board (and sometimes executive) compensation, and it provides important guidance for boards when considering the possibility of such a challenge. The decision also reflects the relative uptick we have seen in demands and challenges from stockholders and plaintiffs’ attorneys relating to board compensation.

Background

The Goldman Sachs decision builds on the Delaware Supreme Court’s 2017 ruling in Investors Bancorp, which concluded that director compensation involves an inherently conflicted decision on the part of a board and that, as a result, in a stockholder challenge to board compensation, a court may apply the entire fairness standard of judicial review, rather than the more deferential business judgment rule, absent adequate stockholder approval of the compensation at issue. [2] Under the entire fairness standard of review, the court examines the fairness of the compensation itself as well as the company’s processes relating to setting the compensation. Because the standard is fact-intensive and searching, it can result in protracted litigation that survives the pleadings stage. Importantly, Investors Bancorp further held that a stockholder vote approving director compensation can effectively preclude an entire fairness claim, but that the stockholder vote must approve specific amounts of compensation or self-effectuating formulas to be effective. This aspect of the ruling appeared to reverse several decisions from the Delaware Court of Chancery concluding that stockholder approval of director compensation within “meaningful limits” could eliminate entire fairness claims. Finally, the Investors Bancorp decision also permitted the plaintiff to challenge executive compensation paid to management members of the board where the board’s deliberations and approvals relating to that compensation appeared sufficiently intertwined with its decisions about director compensation.

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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.

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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.

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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.

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