“You only have to do a few things right in your life so long as you don’t do too many things wrong.” — Warren Buffett
If you are a CEO or director of a Delaware corporation, you enjoy a business-friendly legal framework granting to management strong legal protections against pesky shareholders who presume to tell you how to run things.
Management can call meetings, has substantial control of board nominations, possesses wide latitude in exercising its business judgment even in such matters as executive and board compensation, and can compel aggrieved parties to litigate claims in Delaware courts.
Are Delaware judges being guided by new definitions of the role of the corporation, either purposefully or through osmosis?
However, even Delaware has its limits. The present business environment is moving from equating good governance with total shareholder return to the holistic view that corporations owe obligations to multiple constituencies.
Is this broadened view leaking into the minds of the Delaware judiciary? Do business roundtable admonitions of corporate obligations to workers, the community, ESG and DEI subtly condition jurists to cast a critical eye upon the once sacrosanct realm of CEO and director discretion?
2020 Delaware case law
I dip gently into the vast ocean of 2020 Delaware corporate jurisprudence to illustrate two areas in which tides are shifting away from management primacy. In these areas we see that management “did it wrong.”
The determination of whether the duty of loyalty was breached is fact-dependent. Generally, directors are held only to the business judgment rule in approving transactions: Could a reasonable director come to a given conclusion in the belief that such conclusion was in the best interests of the corporation? As facts get dicey, the presumption in favor of directors may suggest a closer look (“heightened inquiry”) and, if there is some fire behind the smoke, director action must meet the standard that the transaction is entirely fair.
In the Chancery Court decision in Salladay v. Lev, benefit of the business judgment rule was denied a CEO and board in a shareholder suit claiming breach of duty in approving a going private transaction. The defendants argued that they had undertaken action traditionally recognized as “cleansing” the deal of any taint of self-interest, by constituting a special board committee to negotiate the transaction.
In Salladay, however, management erred in sequencing the transaction. The committee was constituted after the CEO, a director, had suggested a price range to the acquirer. Since a majority of the directors had agreed to roll over their equity into the resultant private entity, they had a conflict of interest in voting in favor.
Nor did the general rule, that a transaction will be permitted if favorably voted by a disinterested majority of fully informed shareholders, protect the deal, as the court pointed to failures of disclosure in the proxy statement.
Two factors in the decision seem telling. First, it is not unusual for major or inside stockholders to roll their shares into an acquiring entity; acquirers often seek such ongoing equity as proof they are acquiring a healthy target. However, the typicality of the roll-over did not prevent the finding of a conflict of interest.
Second, while seemingly the committee was independent, was named at an early stage, and had the ability to argue deal price (and did, in fact, negotiate an increase), the engagement of the committee after price discussions caused the loss of the business judgment rule.
The other area revealing heightened responsiveness to shareholder rights was in accommodating shareholders requesting internal corporate records. Such cases arise when investors, suspecting insider dealing, seek to obtain records under Section 220 of the Delaware General Corporation Law. Over time, lawyers had become educated in how to thwart such requests, creating delay and forcing unreasonable shareholder expense.
In a significant series of decisions in 2020, Delaware courts clarified the primacy of Section 220 shareholder rights. The Supreme Court held that shareholders need not prove that alleged wrongdoing was actionable, nor disclose how they intended to use information obtained, as only a “credible basis for suspicion” need be shown (AmerisourceBergen Corporation).
Chancery decisions made clear that companies cannot wage wars of attrition against shareholders exercising statutory rights, that an action to obtain documents is not the time to argue any underlying claim of breach of duty, that shareholders have the “lowest possible burden of proof,” that shareholders need not show probable wrongdoing but only its possibility, and that hassling shareholders may cause a shift of fees to the company (Petty v. Gilead among others).
Further, although the Delaware statute also specifically states a stockholder’s request for information in order to value its shares is a proper purpose, the company cannot inquire as to the reason the stockholder seeks such valuation (Woods v. Sahara).
Are we at the start of a wave of judicial change wherein altering perceptions of the role of corporations will affect Delaware jurisprudence? Or, are we simply watching evolution of case law in an intensely litigious forum?
The February 2021 Chancery decision striking down a poison pill (The Williams Cos. Litigation) can be read as consistent with prior case law, but it makes clear that just because management feels vulnerable to take-over when its stock price drops, that is not alone viewed as justifying a pill when shareholders might benefit from interest of activist investors or acquirers.
Below are some issues, ubiquitous in today’s corporate discussion, in which management’s view might differ from stockholder interests; if presented in the context of Delaware litigation, will courts be “reoriented” in favor of plaintiff shareholders? Or, do these policy differences fall outside a consideration of breach of duty, to be best handled by SEC proxy regulation and by market forces?
NASDAQ recently proposed a regulation requiring board diversity disclosure and action (the SEC has at least for now withheld approval). Many countries and a couple of states have legislated in this area. Will board and management failure to address DEI issues form the basis of actionable shareholder complaints?
On March 29, shareholders filed a Chancery Court action against management and the board of Pinterest (echoing claims previously asserted in California litigation), alleging corporate injury by reason of systemic racism and sexism in employment.
Injury might arise both because the company might face costly damage suits, and because its marketing to primarily female customers lacked important input, given that female employee advice was systematically devalued. Is this a claim of breach of fiduciary duty that will be upheld in Delaware courts? Or is this an issue of everyday management, which should reside with executives reporting to directors?
An SEC representative recently suggested that corporations exercise “corporate hygiene” when executives sell stock under pre-established written “10b-5-1 plans” to avoid insider trading liability while possessing material inside information; later, executives may abort scheduled trades based on inside information. Do shareholders have a claim of market manipulation, or breach of the duty of loyalty?
In March, the acting head of the SEC called for revamping shareholder proxy disclosures to reflect “soaring demand” by shareholders for environmental, social and governance information. Will management and boards breach any duty, perhaps even an oversight duty under the much ignored but now resurgent Caremark duty of board oversight, if they fail to move properly on ESG matters?
The Harvard Law School Program on Corporate Governance, often critical of what happens in boardrooms rather than whether CEOs sign broad policy statements, has criticized corporate leaders, in acquisitions, for using their bargaining power “to obtain gains for shareholders and themselves, but they made very little use of their power to negotiate for protection of any stakeholders.” (“For Whom Corporate Leaders Bargain,” Professor Lucien Bebchuk, Director, abstract 3677155)
Will shareholders bring suit against management and boards for effecting acquisitions that, while highly beneficial to the shareholders, failed to preserve jobs against consolidation, or failed to maintain a factory in a small dependent town, or failed to make a deal with an acquirer with a more progressive ESG or DEI agenda?
In February 2021, the highly regarded Analysis Group issued a capital markets study demonstrating that corporations recently have been expending more profits for distribution (dividends and buybacks) than to reinvest in their companies. Since I believe there is a bias to protect long-term “main street” investors as opposed to traders and short-term players, will boards suffer shareholder litigation claiming they have short-changed the long-term interests of the company’s “real” shareholders?
In March, a Tesla investor sued Elon Musk for injuring the company by Musk violating his 2018 settlement with the SEC over his tweets. The board was named as failing to ensure compliance. Would Chancery find that shareholders had a good claim against directors? (Perhaps a hard case to sustain as the stock price has since soared, but what if investors sold their shares before?)
Are Delaware judges being guided by new definitions of the role of the corporation, either purposefully or through osmosis? If so, is the process so subtle that we will not recognize ongoing changes until, a decade in the future, we look back and realize that corporate law has moved a long way by small, invisible steps?
Stephen M. Honig practices at Duane Morris in Boston.