The Delaware Law Series


Chancery Court Enjoins Annual Meeting in Defense of Stockholder Franchise

Andrew Freedman, Lori Marks-Esterman, and Kenneth Silverman are partners at Olshan Frome Wolosky LLP. This post is based on an Olshan memorandum by Mr. Freedman, Ms. Marks-Esterman, Mr. Silverman, Jacqueline Ma, and Matthew Traylor, and is part of the Delaware law series; links to other posts in the series are available here.

The Delaware Chancery Court recently preliminarily enjoined a stockholders meeting in Bray v. Katz, No. 2022-0489-LWW (Del. Ch. June 24, 2022) (transcript). The case concerns a board of directors’ decision in advance of the upcoming annual meeting to lower the quorum requirement for stockholders meetings; it did so in order to preempt certain stockholders from blocking the election of the company’s slate of director nominees. The Court concluded that the board of directors acted with the primary purpose of impeding the exercise of stockholder voting power. Accordingly, the Court determined that the board’s actions implicated the heightened Blasius standard of review, which requires defendants to demonstrate a “compelling justification” for frustrating the stockholder franchise. In an exacting bench opinion, the Court found that defendants failed to demonstrate any such justification. Vice Chancellor Will’s ruling demonstrates the close scrutiny Delaware courts give to corporate acts that entrench the board and disenfranchise stockholders.

Background

UpHealth Inc. (the “Company”) had a nine-person classified board (the “Board”) with two co-chairs. Defendant Avi Katz (“Katz”), founder of the Company’s SPAC sponsor, GigCapital, served as one co-chair; the other co-chair was legacy UpHealth founder and plaintiff Chirinjeev Kathuria (“Kathuria”). The Company’s Class I directors, each serving three-year terms, were up for election at the 2022 annual meeting, originally scheduled for June 28, 2022.

After the Nomination Window Closes, A Majority of the Board Changes the Slate

The Company’s advance notice deadline passed on April 25, 2022, without any stockholder proposing any nominees for election.

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Delaware’s Shifting Judicial Role in Business Governance

Randall S. Thomas is Professor of Law and John S. Beasley II Chair in Law and Business at Vanderbilt University School of Law, Robert B. Thompson is Peter P. Widenbruch, Jr. Professor of Business Law and Georgetown University Law Center, and Harwell Wells is I. Herman Stern Professor of Law and Temple University James E. Beasley School of Law. This post is based on their recent paper, forthcoming in The Business Lawyer, and is part of the Delaware law series; links to other posts in the series are available here.

What do Delaware judges do all day—and what does it mean for the governance of American businesses? In our new article, “Delaware’s Shifting Judicial Role in Business Governance,” we take a close look at the work of the country’s preeminent business court, Delaware’s Court of Chancery, in order to examine the changing nature of judicial review of governance of American businesses. Drawing on a detailed study of all cases filed in 2018 in Delaware, and comparing our findings to a previous survey of such litigation two of us performed almost twenty years ago, our new study reveals that the past two decades have seen fundamental changes both in the corporate and business law issues brought before the Chancery Court and in the kind of work that court is doing.

Once the bulk of the court’s work was straightforward: the Chancellors applied fiduciary duties to resolve governance disputes in publicly held corporations. The common law of fiduciary duties, as developed by the court, was (and remains) the backbone of corporation law in the United States. When for instance takeovers became the dominant corporate governance issues in the 1980s, the court issued a series of opinions applying fiduciary duties to the facts and developed a new jurisprudence for mergers and acquisitions in cases such as Unocal, Revlon, and Blasius. Our previous study, which looked at all cases filed in 1999 and 2000, found that the main work of the Court of Chancery during that period was to apply fiduciary duties to resolve disputes over the governance of publicly traded corporations, usually in an acquisition setting.

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Risk Management and the Board of Directors

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, Rosen & Katz memorandum.

1. INTRODUCTION

Overview

As companies seek to navigate a multi-stakeholder global landscape and the world continues to adjust to the impacts of Covid-19, significant new risks have emerged that are reshaping the near-term business and risk landscape. These new risks—and the intensification of longstanding risks—are pressure-testing the agility and resilience of corporate strategies, risk management systems and practices. The pandemic accelerated technological disruptions and business model changes and exposed sharp differences in the impacts felt by different sectors, with some experiencing enormous dislocation and others doing remarkably well and arguably emerging stronger. Looking ahead, all sectors of the economy are facing macroeconomic headwinds, including persistent inflation, surging interest rates, continued supply-chain bottlenecks and commodity shortages, all occurring amid the backdrop of the war in Ukraine, China’s zero-Covid policy and growing geopolitical tensions. Severe drought, heatwaves and flooding across the globe have highlighted the burgeoning challenge of climate risks, which, along with the tight labor market and declining fertility rates across the developed world, present near- and longer-term risks that will require significant planning. Cybersecurity also continues to be a significant threat with regulators stepping up focus in step with growing geopolitical risks. In the United States, the 2022 midterms and ongoing political polarization continue to create uncertainties and surprises that companies will need to prepare for and address.

More than two-thirds of organizations surveyed by the American Institute of Certified Public Accountants (“AICPA”) noted that perceived risk volumes and complexities remain elevated as companies across all sectors continue to deal with the litany of risks noted above. Surveyed organizations also recognized a “need for real change in how organizations govern business continuity and crisis management” in light of growing pressures from stakeholders for more disclosure about risks and heightened demands on management and boards to enhance effective risk management and preparedness for unexpected risk events. The World Economic Forum’s Global Risks Report 2022 highlighted the economic and societal ramifications of the Covid pandemic, noting that domestic and global fragmentation may worsen the pandemic’s impacts and complicate the coordination needed to tackle the challenges ahead.

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DGCL Amendment Merits Amending Charters and Engagement with Institutional Shareholders

Ethan Klingsberg is partner and Oliver Board is counsel 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.

Amendments to the charters of Delaware corporations are advisable as a result of a new amendment, effective August 1, 2022, to the Delaware General Corporation Law (the DGCL) that permits the extension of exculpation rights to executive officers.

Delaware law has long permitted a corporation to include a provision in its certificate of incorporation that eliminates or limits the personal liability of directors for monetary damages arising from their breaches of fiduciary duty, subject to basic exceptions. Delaware has now amended Section 102(b)(7) to expand this exculpation right to be available to cover executive officers as well.

This amendment to the DGCL is a response to the increasing frequency of shareholder suits where the plaintiffs name executive officers, including general counsels, as defendants. Often these suits follow the closing of a sale of the corporation. It is not uncommon for such suits to include a claim that the general counsel breached his or her duty of disclosure in connection with the preparation of the merger proxy statement or Schedule 14D-9. Others have alleged that the general counsel engaged in conduct that impeded the fulfillment of the Revlon duty to seek the best price reasonably available when selling control of the corporation. In some of these cases, the courts have dismissed claims against some of the pre-closing directors, because they were exculpated under the corporation’s charter, but allowed claims to proceed against the pre-closing officers, because, prior to this amendment to Section 102(b)(7), they could not be exculpated from personal liability in a similar manner.

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The Corporate Law Reckoning for SPACs

Minor Myers is Professor of Law at the University of Connecticut School of Law. 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. Related research from the Program on Corporate Governance includes SPAC Law and Myths (discussed on the Forum here) by John C. Coates.

The ascendance of SPACs in U.S. capital markets has attracted intense regulatory scrutiny from federal officials, especially the SEC. This federal attention on SPACs is natural, as at first glance the SPAC appears to be simply an alternative to the conventional IPO, itself regulated chiefly at the federal level. The SPAC, however, is critically different from the IPO. An IPO is a transaction: the issuer sells stock, and public purchasers buy it, and the issuing corporation owes no fiduciary duty to the IPO purchasers. By contrast, the SPAC is an entity, not a transaction. And in fact SPACs are a very particular kind of entity: a standard corporation, organized usually under the laws of Delaware. My paper is the first to examine the corporate law dynamics of SPACs in detail, and it makes two distinct claims.

First, it demonstrates that the SPAC industry has exhibited a striking disregard of corporate law, failing to live up to basic equitable and statutory expectations under existing doctrine. Compared to other public corporations, the SPAC adopts a highly idiosyncratic governance model. The SPAC vests near-despotic control over all substantive decision-making in the hands of the sponsor. And SPAC boards are always populated by persons selected by the sponsor and often classified, making it impossible to wrest control from the sponsor during the life of the SPAC. The merger vote is engineered to achieve success, as the redemption right and warrants induce stockholders to vote in favor of a transaction regardless of their views on its merits, and the redemption decision likewise affords public holders limited influence. At the same time, the all-powerful sponsor has a deep conflict of interest with public holders. With a business combination, the sponsor secures a 20% stake, a potentially gargantuan reward. Without one, the sponsor’s stake is worth nothing. The result is that the sponsor has two incentives at odds with the public holders: to pursue any transaction, regardless of its advisability for public stockholders, and to obscure that fact from public stockholders to minimize redemptions. The sponsor acts unconstrained by any customary corporate mechanism for handling conflicted situations, as there are no disinterested decisionmakers anywhere in the SPAC. A SPAC thus offers its business combination to the public holder as a take-it-or-leave-it proposition, from which the investor has a custom-built remedy that is reputed to be complete. I call this approach the private fund model, as it broadly characterizes the structure that prevails among private investment funds.

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Delaware and Caremark: An Update

Theodore N. MirvisDavid A. Katz, and Sabastian V. Niles are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell 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 Monetary Liability for Breach of the Duty of Care? (discussed on the Forum here) by Holger Spamann.

Recent Delaware decisions have reminded boards of directors of the obligation to make a good faith effort to put in place a compliance system designed to help ensure that their companies operate within the bounds of the law and that their products, services, and operations do not cause harm to consumers, community members, or the environment. That duty—famously associated with the Delaware Court of Chancery’s 1996 decision in Caremark—is a core responsibility of independent directors, working in concert with company management, that requires them to make a good faith effort to identify the key compliance risks the company poses to others and faces itself, and to put in place a reasonable oversight structure to address them.

In 2019, the Delaware Supreme Court’s decision in Marchand reminded boards that although the Caremark standard only requires a good faith effort to put in place and attend to a reasonable compliance structure, a plaintiff could state a claim against directors by pleading facts suggesting that the board failed to make any effort to ensure that a board-level system of oversight was in place to address a mission critical risk. In that case, the company’s sole business was to make ice cream and there was no board-level process for monitoring the safety of its products, which caused the death and illness of consumers in a listeria outbreak. Just last year, the Court of Chancery issued a high profile decision in the Boeing case, applying Marchand in the face of detailed fact pleadings suggesting that the company had no board-level process for overseeing the company’s effort to ensure the safety of its aircraft.

In those and other cases, the increasing use of books and records demands by plaintiffs to plead their claims has been illustrated. Because the Delaware courts have long made clear—including in Marchand and Boeing—that Caremark requires a good faith effort by the board, not perfection, and that the board will only face liability if the evidence demonstrates that a board has not made a good faith effort to fulfill its duties, plaintiffs have sought books and records to sustain their difficult burden to plead a viable claim. When these books and records do not reflect that a company had in place a board structure that attended to core business and legal risks, the plaintiffs cite to that lack of effort in an effort to plead a complaint that cannot be dismissed on motion.

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Chancery Decision Expands the Court’s Approaches on Director Independence

Gail Weinstein is Senior Counsel, and Steven J. Steinman and Brian T. Mangino are Partners at Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Steinman, Mr. Mangino, Matthew V. SoranRandi Lally, and Mark H. Lucas, 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 (discussed on the Forum here) by Lucian Bebchuk and Assaf Hamdani.

The Goldstein v. Denner (May 26, 2022) litigation arose out of the $11.6 billion cash acquisition of Bioverative, Inc. (which had recently been spun off from Biogen, Inc.) by Sanofi, S.A. The Delaware Court of Chancery held, at the pleading stage of litigation, that certain directors and officers of Bioverative may have breached their fiduciary duties in connection with the sale process. The plaintiff claimed that the defendant directors and officers sold the company (in a single-bidder process) too quickly after the spinoff; at a price far below the company’s stand-alone value (as indicated by the company’s projections prepared in the ordinary course of business); at a time when the universe of potential buyers was limited (due to tax-related restrictions following the Spinoff not expiring for another few months); and with materially inaccurate and misleading disclosure to the stockholders.

The sale process was led by an outside director, “D,” an activist investor, who allegedly was acting in accordance with his “usual playbook” of pressuring a public company into putting him on the board, then recruiting his “supporters” onto the board, and then forcing a near-term sale of the company. In this case, allegedly, he had “supercharged” the process by having the hedge fund he controlled (the “Fund”) buy a significant stake in the company after Sanofi first approached him about its in interest in acquiring the company, and then waiting until the expiration period for disgorgement of short-swing profits under Section 16(b) of the Exchange Act to inform the board of Sanofi’s interest and initiate the sale process.

In an opinion that clarifies, and arguably expands, the court’s current approaches on important topics, Vice Chancellor Laster found, at the pleading stage of litigation, that it was “reasonably conceivable” (the standard for survival of claims at the pleading stage) that all of the defendant directors and officers committed unexculpated breaches of their fiduciary duties in connection with the sale process. The court reserved judgment for a future decision on the claim that D’s Fund aided and abetted D’s alleged fiduciary breach.

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Delaware Approves Permitting Exculpation of Officers from Personal Liability

Theodore N. Mirvis, David A. Katz, and Sabastian V. Niles are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum, and is part of the Delaware law series; links to other posts in the series are available here.

For over 45 years, Delaware law has permitted directors of Delaware corporations to be exculpated from personal monetary liability to the extent such protections are set forth in the certificate of incorporation, subject to certain exceptions. However, such protective statutory provisions did not reach officers. As contemplated in our April 2022 memorandum, Delaware has now adopted important amendments to Delaware’s General Corporation Law that would expand the right of a corporation to adopt an “exculpation” provision in its certificate of incorporation to cover not only directors (as has been allowed and widely adopted since 1986, following Smith v. Van Gorkom) but now also corporate officers

The officer liability exculpation provision is not self-effectuating; instead, the amendment to Delaware law allows companies to take action to adopt exculpation provisions that protect covered officers from personal liability on the same basis as directors—that is, for all fiduciary duty claims other than breaches of the duty of loyalty, intentional misconduct or knowing violations of law—with an additional exception that claims against officers will not be barred “in any action by or in the right of the corporation.” 

Under the newly amended provision of Delaware law, covered officers eligible for such exculpation from liability, if implemented by the corporation, will include the president, chief executive officer, chief operating officer, chief financial officer, chief legal officer, controller, treasurer or chief accounting officer, the company’s most highly compensated executive officers as identified in SEC filings and certain other officers who have consented (or deemed to have consented) to be identified as an officer and to service of process. Companies and boards themselves will retain the right to bring appropriate actions against officers, and this additional exception will permit stockholder derivative claims against officers for breach of the duty of care to continue to be brought if demand requirements are met.

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Sale of Portfolio Company is Subjected to Entire Fairness Review

Gail Weinstein is Senior Counsel, and Steven J. Steinman and Brian T. Mangino are Partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Steinman, Mr. Mangino, Matthew V. SoranRandi Lally, and Mark H. Lucas, and is part of the Delaware law series; links to other posts in the series are available here.

In Manti Holdings v. The Carlyle Group (June 3, 2022), the Delaware Court of Chancery held that entire fairness review would apply to the challenged sale of The Carlyle Group’s portfolio company, Authentix Acquisition Corp., due to the pressure Carlyle allegedly exerted to cause a quick sale so that it could close out its fund, Carlyle Holdings, that had invested in the company. The court acknowledged that controlling stockholders generally have the same incentive as other stockholders to maximize stockholder value in a sale to a third party and that, as a result, a controller’s desire for liquidity typically has not been a basis for rejecting business judgment review of a challenged transaction. In this case, however, the court viewed Carlyle’s alleged desire to close out its fund as having rendered it conflicted such that the more stringent entire fairness standard of review was applicable. Vice Chancellor Glasscock wrote: “[T]he reality is that rational economic actors sometimes
do place greater value on being able to access their wealth than on accumulating their wealth.”

Key Points

  • The decision reinforces the court’s trend in recent decisions in finding it plausible that a sponsor’s desire for liquidity may create a disabling conflict. Notably, however, the factual context in which the court reached its decision included the board not having established a special committee to exclude the sponsor-affiliated directors; testimony that Carlyle exerted pressure on the directors to approve the merger; and a non-ratable benefit from the merger for the sponsor in obtaining a profit on its preferred stock investment while the holders of the common stock received almost nothing.

Background. To encourage Carlyle to invest in and become a controller of Authentix, the stockholders had entered into a stockholders agreement pursuant to which they agreed not to oppose any sale of Authentix approved by the board and by a majority of the outstanding shares (in other words, approved by the board and Carlyle). In 2017, the board and Carlyle approved a sale of Authentix to Blue Water Energy for $70 million. Under the terms of the stockholders agreement, the holder of the company’s preferred stock was entitled to receive the first $70 million of consideration paid in a sale of the company. Thus, with a sale at $77.5 million, Carlyle (as the holder of Authentix’s preferred stock) would make a profit on its preferred stock investment but the common stockholders (including the plaintiffs) would receive almost nothing for their stock. Litigation ensued. In previous decisions in the case, the court held that the terms of the stockholders agreement (i) constituted a waiver by the common stockholders of their statutory appraisal rights and (ii) did not preclude the plaintiffs from bringing a fiduciary suit against Carlyle and the Authentix directors. In this most recent decision, the court held that the plaintiffs had adequately stated a claim for breach of fiduciary duties by Carlyle and the Carlyle-affiliated directors on the Authentix board.

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The Single-Owner Standard and the Public-Private Choice

Charles Korsmo is Professor of Law at Case Western Reserve University School of Law and Minor Myers is Professor of Law at the University of Connecticut School of Law. This post is based on their recent paper, forthcoming in the Journal of Corporation Law, and is part of the Delaware law series; links to other posts in the series are available here.

A fundamental question in corporate law is the nature of the stockholders’ ownership interest in the firm. Should a share of stock be viewed as a simple chattel, the value of which can be measured for all purposes by its trading price? Or should it be viewed as a partial claim on the firm as a whole, the value of which—for some purposes—cannot be determined without reference to the value of the entire firm to a single owner? This question arises in a number of contexts involving intra-corporate disputes, the most important of which is the merger. When examining whether a target board has satisfied its fiduciary duties, or when determining the “fair value” of the stockholders’ shares, a court must confront this fundamental question of the shareholders’ entitlement.

Delaware law has long entitled stockholders to a proportionate share of the value of the firm as a whole to a single owner and not simply the trading value of their fractionalized shares. This conception—the “single-owner” standard—was first articulated in the context of appraisal rights, and it has served for a century as the Atlas of Delaware’s corporate law, providing the theoretical foundation for its entire doctrinal universe, including merger landmarks like Unocal, Revlon, and the long line of their offspring. The single-owner standard provides the justification for allowing target boards to employ takeover defenses to fend off bids at a premium to the stock price and for the traditional measures of fair value in appraisal and breach of fiduciary duty actions.

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