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Bankruptcy: A Look Back and a Look Ahead

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Bankruptcy Event     On Wednesday, October 22, 2014, the Institute of Delaware Corporate and Business Law presented Bankruptcy: A Look Back and a Look Ahead.  The program was initially intended to feature Judge Helen S. Balick on the subject of the Bankruptcy Act, and bankruptcy as it developed under the Bankruptcy Reform Act of 1978 (the “Bankruptcy Code”).  But due to Judge Balick’s recent accident, Chief Judge Brendan L. Shannon and Judge Peter J. Walsh, of the U.S. Bankruptcy Court, participated in her stead.  The program, conducted in conversation-style format, was moderated by Bruce Grohsgal, the Helen S. Balick Visiting Professor in Business Bankruptcy Law at Widener University School of Law, Delaware.

Early in the program, Chief Justice Shannon recounted Judge Balick’s background and professional history as set forth in an oral history he had conducted in April 2014.  The account of Judge Balick’s remarkable personal and professional career set a tone of tribute that permeated the entire program.

Judge Walsh, when asked what was it like to practice in the 1960s and 1970s compared to now, explained that bankruptcy in Delaware was a local practice until In re Cont’l Airlines, Inc., 125 B.R. 399 (D. Del.) aff’d and remanded, 932 F.2d 282 (3d Cir. 1991) (“Continental”).  There were no New York or Chicago firms and the cases were all relatively small cases.  There were not really a lot of other bankruptcy professionals, and he used to appear before Judge Balick at least once a week.  When he assumed judgeship in 1993, his staff consisted of only three people.  There was only one bankruptcy courtroom, so he and Judge Balick would have to coordinate their schedules to avoid double booking.

Chief Judge Shannon, when asked what is was like to practice before Judge Balick as a young lawyer, explained that Judge Balick was remarkably kind, especially to young lawyers.  Chief Judge Shannon had been admitted to practice in 1992, right after Continental, which was a “staggeringly busy time” for bankruptcy attorneys.  Because of the fast pace, his early practice was challenging, and he had to appear before Judge Balick almost every day.  He described how Judge Balick always gave guidance to young attorneys without embarrassing them.

Chief Judge Shannon then highlighted Judge Balick’s “no nonsense” tone, and noted that her approach has been adopted to varying extents by other judges.  He explained that Judge Balick set the tone that the court would get to the merits and would not let procedural issues hang up the case.  This tone created a really valuable dynamic that enabled the parties to proceed to the merits.  He further noted that the importance of proceeding to the merits is part of Judge Balick’s legacy, and has been instilled to a certain extent in the courts today.

Judge Walsh and Chief Judge Shannon remarked that Continental, followed by In re Columbia Gas Sys., Inc., 136 B.R. 930 (Bankr. D. Del. 1992), changed the practice of bankruptcy in Delaware.  Perhaps not coincidentally, Judge Balick presided over both cases.  Chief Judge Shannon expressed that the two cases were dealt with promptly and that Judge Balick’s “no-nonsense” approach minimized uncertainty and delay, which was important to counsel on both sides.

As Chief Judge Shannon and Judge Walsh recounted cases that had been argued and heard before Judge Balick, the program developed a nostalgic atmosphere.  Reminiscing about past cases from their days in practice, the judges described a much smaller and tight knit bar, prior to the advent of the larger cases that began in the 1990s.  Judge Shannon and Judge Walsh’s high regard for Judge Balick, as formers and as colleagues, reflected the enduring impact of Judge Balick’s career and legacy.

 

 

 

Delaware and the Development of Corporate Governance

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At the 30th annual Francis G. Pileggi Distinguished Lecture in Law, Brian R. Cheffins, the S.J. Berwin Professor of Corporate Law at the University of Cambridge, evaluated Delaware’s contribution to the development of corporate governance over the past forty years.  Professor Cheffins posited that although Delaware is often identified as having a substantial impact in the field of corporate governance, it has not been the sole player and has not always been the dominant player in the development of corporate law.  Yet, any analysis of the historical development of corporate governance would be seriously incomplete without a consideration of Delaware and Delaware courts.

In the lecture, Professor Cheffins first asserted that due to the nature of the legislature and the judiciary, Delaware’s key corporate players, expectations concerning Delaware’s potential impact should be kept in check.  He then explained his position that Delaware has not been as impactful in the areas of shareholder activism and executive pay, but has made substantial contributions in the development of boards of directors and takeovers.

Delaware’s Key Corporate Players—the Legislature and the Judiciary

Beginning with the Delaware General Corporation Law (“DGCL”), which has been identified as the formal apex of the structure of Delaware Corporate Law, Professor Cheffins noted that the DGCL has not been overhauled since 1967, before corporate governance became prominent.  Therefore, it was not likely to be the “first mover” on corporate governance; put differently, Professor Cheffins asserted that because the DGCL predated the prominence of corporate governance, it cannot be said to have had a transformative effect on the development of governance standards.  He further noted that Chief Justice Strine has stated that the “Delaware Model” for corporation law makes the DGCL an unlikely foundation for the imposition of governance standards.

Next, in analyzing the role of the Delaware judiciary, Professor Cheffins observed that because of Delaware’s approach to corporate law, Delaware courts have a broad scope to define director’s duties.  This discretion has created the potential for the Delaware judiciary to play a significant role in the development of corporate governance.  But while they have had a profound impact on changes in corporate governance law, Delaware Courts tend to reinforce already-existing trends, rather than foster radical change.

In comparing the legislature and the judiciary, Professor Cheffins explained that with the judiciary, cases tend to be skewed because most filings involve one type of case: a class action challenging actions taken by directors in an acquisition.  Nevertheless, Delaware judges are skilled at creating broad rules and exerting influence on matters not specifically raised by litigants and not before the courts.  The legislature, on the other hand, is not constrained by doctrine and precedent, and can create wide regulatory schemes.  Where courts are constrained, the legislative body can open up doctrine and theoretically investigate and formulate new doctrine.

Delaware’s Influence on Areas of Corporate Governance

After summarily concluding that Delaware’s contribution to shareholder activism has been marginal largely because of institutional constraints, and that Delaware played a largely peripheral role in the transformation of executive pay in the late 20th century, Professor Cheffins, examined Delaware’s role in the development of corporate boards and the decline of hostile takeovers.

Regarding the board of directors, Professor Cheffins set forth that Delaware played a substantial role in rise of independent directors and in establishing standards of deliberation.

Citing Delaware cases in which the independence of the board was seen as a factor in the outcome—Unocal Corp. v. Mesa Petroleum Co., 493 A.2d 946 (Del. 1985), Moran v. Household Int’l, Inc., 500 A.2d 1346, 1349 (Del. 1985), and Paramount Comm’ns, Inc. v. Time Inc., 571 A.2d 1140 (Del. 1989)—Professor Cheffins observed that an indication by Delaware courts that decisions by independent directors would be less scrutinized than decisions by interested parties helped lead to a rise in the importance of independent directors. Yet, despite acknowledging that Delaware courts contributed to the rise of the independent director, Professor Cheffins maintained that Delaware courts were merely reinforcing already occurring key trends in changes to the board.  He further explained that Sarbanes-Oxley and other regulatory reforms in the early 2000s were not transformative because they largely conformed to corporate governance norms shaped by Delaware case law.  Delaware courts had helped transform the legal landscape, and the regulatory reforms went a long way towards mandating the numerical dominance of independent directors and independent committees on boards.

As to the standards of deliberation, Professor Cheffins acknowledged the influence of Delaware case law, but maintained that Delaware’s impact could have been more extensive.  Noting that Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985), a case where outside directors of a publicly traded company faced out-of-pocket liability, was widely credited with sensitizing the business community to the deliberative responsibilities of boards, Professor Cheffins expressed that the fears of personal liability may not have been well-founded because a statutory amendment, DGCL § 102(b)(7), permitted restrictions on board liability in the corporation’s charter.  Later, the Disney/Ovitz litigation, In re Walt Disney Co. Derivative Litig., 907 A.2d 693 (Del. Ch. 2005) aff’d, 906 A.2d 27 (Del. 2006), further eased the fears of growing liability risks in Delaware courts.  According to Professor Cheffins, Disney, characterized as “the corporate governance case of the century,” provided Delaware courts with a fresh opportunity to adjudicate on directors’ responsibilities to be more attentive; but the court’s ruling of no liability on the directors likely muted its impact.

Regarding takeovers, Professor Cheffins contended that factors outside of Delaware must have helped to prompt the switch in emphasis from the market for corporate control to internal governance mechanisms.

Observing that Delaware courts were “in the center of the action” during the Deal Decade,[1] Professor Cheffins acknowledged that Delaware rulings that upheld defensive steps taken by boards may have helped bring the deal decade to a close.  He nevertheless put forth that while the Paramount decision, Paramount Commc’ns, Inc. v. Time Inc., 571 A.2d 1140, 1142 (Del. 1989), is largely credited for helping to bring the deal decade to an end, Delaware case law was only one component of a legal matrix that worked to the disadvantage of a hostile bidder.  Explaining that changing market conditions at the end of the 1980s made banks reluctant to lend to those seeking to carry out takeovers, Professor Cheffins posited that other factors must have helped to prompt the switch to internal governance mechanisms at the close of the deal decade.

To further support his contention that factors outside of Delaware must have helped to prompt the switch to internal governance mechanisms, Professor Cheffins examined DGCL § 203, Delaware’s anti-takeover law.  He noted the general thinking that § 203 was of limited practical importance so long as boards had substantial discretion to adopt poison pills.  He then asserted that Delaware case law indicating that boards had substantial discretion to deploy poison pills was not decisive because poison pills are relatively harmless unless coupled with a staggered board, and only a subset of Delaware companies had staggered boards combined with the poison pill.  Therefore, a poison pill did not necessarily render § 203 moot.

Conclusion

Professor Cheffins concluded the lecture by emphasizing that any discussion of the development of corporate governance in the United States would be seriously incomplete without accounting for Delaware’s role.  Nevertheless, other players and factors were at play, and even in the areas where Delaware was most influential, it tended to reinforce trends rather than foster radical change.

In response to a question posed by Professor Lawrence Hamermesh, director of the Institute of Delaware Corporate and Business Law, Professor Cheffins explained that the ability of Delaware to accept certified questions was not crucial to past developments but could be significant moving forward.


[1] A decade in the 1980s exemplified by aggressive bidders seeking to engineer takeover bids by offering generous premiums to shareholders of target companies to secure voting control

Musings on Future Legal and Regulatory Developments Affecting Shareholder Activism

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Eric Talley[1]at Berkeley, and the Berkeley Business Law Journal[2], put together a great conference[3] on April 4, 2014 on shareholder activism, and I scratched out the following thoughts for our panel.  We were supposed to talk about the prospects for further regulatory and legal developments governing or motivating shareholder activism.  First, though, consider what legal rules facilitate activism – and when you do that, you discover that any change is likely to be marginal at best.  Given my working definition of shareholder activism – using share ownership to promote concerted action, by large numbers of shareholders, to exercise the legal rights of shares – the following are key legal rules that enable this to occur:

  • Putting aside the unusual case of dual class capital structures, stockholders will have one vote per share;
  • They will be entitled to vote on the election of directors at annual meetings;
  • They will be entitled to vote on mergers and, at least in Delaware, those transactions will require approval from a majority of the outstanding shares – and maybe even a majority of public or minority shares, in the case of a going private transaction;
  • Putting aside the currently unusual situation of a stock for stock deal, stockholders will have the right to seek a judicial appraisal of their shares.

All of these features of our legal system that do so much to facilitate shareholder activism have virtually no chance of being eliminated or changing in any dramatic way.

So where do I expect to see regulatory and other legal movement in relation to shareholder activism?  Two possible areas of change have been discussed at the federal level:

  1. Disclosure of a 5% ownership position as required by Section 13(d) makes block acquisitions more expensive, so we’re seeing renewed pressure from Wachtell, Lipton[4] and others arrayed against shareholder activists to close the 10-day window in which share buying can continue, past the 5% level, without public disclosure – and perhaps, while fellow activists are tipped off about the activity before the investing public generally.  And we’re seeing their opponents, like Lucian Bebchuk[5], pressing in the other direction, urging that activism by large blockholders is beneficial to investors generally, and the incentives to accumulate such share blocks shouldn’t be impaired.  So will the window ever get closed?  It’s been talked about, again and again, for my entire professional life, and nothing’s ever been done about it, so forgive me for being skeptical that anything will be done now.  Perhaps more plausibly, there will be further development of the law of groups and common beneficial ownership based on concerted activism.  Certainly those who would prefer to discourage activism would prefer to see this body of law develop more aggressively, but again, this idea has been around for a long time and at least so far activists have been well counseled enough to have avoided serious scrapes with 13(d).
  2. Shareholder access to company proxy statements for shareholder proposals, under Rule 14a-8, is a handy activist tool, but we’re now seeing renewed efforts[6] to trim back its availability, by raising minimum ownership requirements and raising the bar for repeat proposals that don’t get a lot of support when first proposed.  These efforts may be less aimed at activists, though, than at the John Cheveddens of the world.  In any case, I’m not optimistic that a consensus will form to do anything on this subject either, or that it in any event would limit the use of 14a-8 by a well-heeled activist.

Much more interesting to me are two state corporate law battlegrounds.  The first one involves various aspects of the right to nominate directors.  Running short slates is, of course, a powerful tool in the shareholder activism kit, and a perennial source of friction as management and activist tectonic plates continually collide.  And there have been a number of recent tremors along that fault line:

  1. Shareholder activist Third Point has a suit pending in the Delaware Court of Chancery[7] seeking relief against Sotheby’s poison pill.  It owns almost 10% of the company, and the directors have adopted a pill that would prevent acquisitions of over 10%, with two notable exceptions:  (i) for acquisitions of over 50% pursuant to an all shares all cash tender offer, and (ii) for persons who buy up to 20%, as long as they confirm that they don’t seek to influence control of the company.  Third Point’s suit claims that the pill is intended not to deter inadequate takeover bids (which is what one usually thinks a poison pill is for), but to impede its effort to elect three dissident directors.  Its challenge is set for a preliminary injunction hearing shortly, before the company’s May 6 annual meeting.  The use (or potential use) of the pill to deter a proxy contest is old news, but this latest chapter is written against the backdrop of the shareholder activist story, as opposed to the more traditional takeover bidder story.
  2. In the last year or so, we’ve seen initiatives by activists seeking to elect candidates to the board to sponsor performance compensation for their nominees.  Corporate managements and their supporters have pushed back[8], in a number of ways.  They criticize these arrangements as improper influences on directors (compromises their independence, it is said, or misaligns their incentives relative to those of stockholders generally).  And for a while last year many corporations were adopting bylaws[9] that purported to disqualify director nominees who were parties to such shareholder-sponsored compensation packages.  In the face of negative recommendations from ISS,[10] though, some of these companies have repealed those bylaws, but the battle is still being fought.  Maybe some day the validity of one of these bylaws will come before the Delaware courts – but I sort of doubt it, honestly; it’s pretty rare to see validity issues actually go all the way to the litigation mat.
  3. In the longer run, I predict other battles along the electoral fault line.  The extent to which boards can adopt bylaws that more generally limit an activist’s right to nominate director candidates is a very undeveloped topic (despite a limited effort on my part[11] in a recent article to explore the subject).  Over time I expect we’ll see disputes about the validity and enforceability of other director qualification bylaws and maybe even minimum share ownership requirements for the right to nominate.

So much for battles over electing directors.  M&A is the other major battleground for shareholder activists, and there have been at least two notable areas in which this conflict has played out:

  1. The first area also involves voting.  There have been some notable successes in shareholder activist efforts to resist going private transactions.  The most famous one, of course, was the Dell acquisition, which saw fierce resistance led by Carl Icahn.  The deal ultimately went forward of course, but with at least modest price bump.  And according to one recent source[12], 71% of activist initiatives in 2013 succeeded in either raising the deal price or terminating a deal, compared to just 25% in 2012 and 19% in 2011.
  2. The other area for shareholder activism in relation to M&A has hit practically epidemic proportions, and is best illustrated in the Dole going private transaction.  I’m referring to the increasing shareholder activist use of statutory appraisal rights.  So I’ll talk briefly about why the increase has occurred, and then suggest some possible pushback that we might see or already be seeing.
    1. The key to it is the rule established in Delaware (back in the Salomon Brothers v. Interstate Bakeries case in 1989[13]) that one can buy shares after a deal is announced and still demand appraisal for the newly acquired shares, as long as you’re the holder on the date of the demand (which can be as late as just before the merger vote).  This practice has been described, plausibly, as “arbing appraisal rights.”  Other attractions include the fact that prejudgment interest is presumptively set by statute[14] at 5% over the federal funds rate – maybe not such a great long-run return on equity, but a darn sight better than market interest rates.  Finally, the risk of getting an appraisal award that’s less than the merger price is not mythological, but it’s not all that salient either, especially in deals like going private transactions, that don’t involve an acquisition by an independent strategic bidder.
    2. So what’s the push back likely to be?  Some have suggested that Delaware needs to fix its rule that shares acquired after deal announcement are entitled to appraisal, and to reduce the assertedly overcompensatory prejudgment interest rate in appraisal cases.  More immediately and practically, I think you’re likely to see even more use of appraisal outs in merger agreements, where the acquirer gets to walk if appraisal demands exceed a specified percentage of the shares.  Andrew Noreuil at Mayer Brown in Chicago put together a nice chart[15] showing that use of such outs actually declined, from 23% of all deals in 2006 to 4.4% in 2012; but it’s on the upswing again (8.2% last year), and I expect that acquirers are going to be even more aggressive about demanding these outs, at least at some level (an out at 10% seems to be the most common so far).
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26th Annual Ruby R. Vale Interschool Corporate Moot Court Competition

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From March 13 to March 16, Widener University School of Law hosted its annual Ruby R. Vale Interschool Moot Court Competition.  Students from twenty-one law schools from the across the country came to Widener to argue Mercer Christian Publishing Co. v. Praise Video, Inc. on appeal to the Delaware Supreme Court.

This case implicated the question of the extent to which Delaware’s recently enacted Public Benefit Corporation Statute affects the contours of Revlon and its progeny.  The parties in the case were Praise Video, a closely-held public benefit corporation with a stated purpose to promote Christian values, and Mercer Christian Publishing Company, a wholly-owned subsidiary of a media conglomerate.

After Praise Video solicited bids, two potential merger partners emerged with offers.  Mercer offered a superior per share price, but the competing bidder was more compatible with Praise Video’s public benefit purpose.  Despite Mercer’s higher offer, Praise Video’s board opted for the competing bid to ensure that Praise Video would continue with its Christian purpose after the change of control.  The board relied on the public benefit statute’s balancing test that allows a board to balance between shareholders’ pecuniary interests, constituents affected by the corporation, and the public benefit purpose when making decisions.  Ordinarily, under Delaware’s well-settled jurisprudence in this context, the board’s decision would have unquestionably been a violation of the directors’ duty to the shareholders to maximize value.  However, because of the new public benefit corporation statute, the question at issue was whether shareholder monetary value could be sacrificed to some extent in the interest of promoting the corporation’s public benefit purpose.

The Honorable Jack B. Jacobs and the Honorable Henry DuPont Ridgeley of the Delaware Supreme Court, Vice Chancellor John W. Noble and Vice Chancellor J. Travis Laster of the Delaware Court of Chancery, and Mr. Simon M. Lorne, Esquire, Vice Chairman and Chief Legal Officer of Millennium Management LLC, served as the distinguished Judges on the bench for the Final Argument.  The advocates consisted of, for the Appellants, Jenna Grassbaugh, Ryan Harmanis, and Hunter West from Ohio State University’s Moritz School of Law, and Zachary Hutchinson and Daniel Woodard, for the Appellees, from Georgetown University Law Center.  After well-argued presentations by both parties, the competitors from Ohio State University’s Moritz School of Law were crowned as this year’s winner.  Competitors Mark Snyder and Alex Yarborough from Seton Hall School of Law were awarded the Donald E. Pease Award for the best brief.  In addition, Mark Snyder received the award for Best Oral Advocate.

On the second day of the competition, Simon M. Lorne delivered to the audience in the Vale Moot Court Room the Vale Distinguished Scholar Lecture titled “Constituency Directors and the Objects of their Attention.”  The lecture focused on the issues related to representative directors and their competing considerations for the shareholders who elected them and their fiduciary duties to the entire company.  Mr. Lorne questioned whether the doctrinal emphasis on serving the interests of the corporation and its stockholder generally adequately acknowledges the reality that representative directors are expected to, and do, serve the interests of the stockholder who chooses them.

Playing a Prevent Defense in a Game Without a Clock – The Need to Amend Section 203

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Guhan Subramanian, the Joseph Flom Professor of Law & Business at Harvard Law School, faced a skeptical bench and bar at the 29th annual Francis G. Pileggi Distinguished Lecture in Law to assert that Section 203 of Delaware’s General Corporation Law needs to be amended before a hostile bidder successfully challenges its constitutionality.  Professor Subramanian was critical of Delaware’s wait and see approach to amending Section 203. He reasoned that because of the drastic decline in the use of poison pills resulting from shareholder activism, removal of the poison pill would leave corporations dependent on Section 203 for a takeover defense, and that corporations may therefore choose to flee Delaware if a constitutional challenge to Section 203 succeeds.

When Section 203 was upheld, back in the late 1980s, federal courts relied on a finding, based on statistical analysis, that the statute afforded a bidder a “meaningful opportunity for success.” However, Professor Subramanian argues this finding was factually incorrect even when made, and that since 1990, no hostile bidder has been able to surmount Section 203’s 85% hurdle, which calls into question whether the decisions upholding it were correct.

Instead of waiting for the shoe to drop and be left with the dilemma to start from scratch, Professor Subramanian proposes that Section 203’s 85% threshold requirement be reduced to 70%.  To support his proposal he points to the shift from effective staggered boards to unitary boards.  According to Professor Subramanian, Delaware missed its opportunity then to amend its corporate code before activists, such as institutional shareholder services, forced corporations to adopt a unitary board system.  He opined that Delaware should not fall into the same trap again and stop the train before it leaves the station, otherwise activists may infect the corporate code with another undesirable change as seen with the unitary board.

Before Professor Subramanian opened the floor to questions from the audience, he asked three questions.  (1) Is the constitutionality of Section 203 settled law?  (2) If not, should a bidder be advised to challenge its constitutionality the next time it becomes a binding restraint?  (3) And if yes, what should Delaware do to avoid this challenge?  According to Professor Subramanian, Section 203’s constitutionality is in question and no plausible reason has been given as to why a bidder would not seek to bring it under judicial scrutiny.

In rebuttal, A. Gilchrist Sparks of Morris, Nichols, Arsht & Tunnell LLP, argued that Section 203 would not be declared unconstitutional based on the Supremacy Clause’s clear and convincing evidence standard.  Mr. Sparks took issue with the interpretation of data used by Professor Subramanian.  Of 1101 bids between 1988 and 2008, 145 were hostile.  In approximately 40% of those bids a transaction was ultimately completed, while another 15% resulted in a white knight deal.  Mr. Sparks asserted that these statistics are evidence of Section 203’s effectiveness to force the board to get the best deal it can get.  Specifically, the hostile-turned-friendly or white knight deals, excluded from Professor Subramanian’s statistics, are likely to be cases where the contestants perceived that the bidder was likely to achieve 85% or more in its tender offer, and where the board accordingly chose to go forward with a sale of the company.  Mr. Sparks concluded from this data that Section 203 does not deny a bidder a “meaningful opportunity of success.”  Moreover, Mr. Sparks discussed his concern about unpredictability that follows in the legislature when initiating an amendment to the code, such as Professor Subramanian proposes.  Lastly, Mr. Sparks argued that the lower 70% threshold would dilute the Section 203’s original intention and, as a matter of public policy, would encourage good corporate form to take on 70% majority ownership.  Chancellor Strine added to the debate by suggesting that Professor Subramanian examine EU regimes identical to Section 203 that have been shown to facilitate change of control transactions.

Professor Subramanian took his chance to respond, and closed by saying that he does not argue that Section 203 would be held unconstitutional.  Instead, he reasons, in light of the incorrect factual analysis from the previous holdings, the statute’s constitutionality remains an unsettled question of law, and therefore Delaware should act preemptively to avoid any potential repercussions.

Visiting Scholar Discusses Stockholder Appraisal in Delaware

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“Delaware occupies such an important place in my teaching and my work that it is an absolute privilege to be here,” said Brooklyn Law School Associate Professor Minor Myers to an audience of faculty, students, and staff on Tuesday, November 12th before launching into the substance of his talk, “Do the Merits Matter in Stockholder Appraisal?”

Myers, the 2013 visiting scholar in residence in business and corporate law, also spoke on Monday, Nov. 11 at 4 p.m. at The Wilmington Club to members of the Delaware bench and bar. The annual visiting scholar program was developed to provide a venue for rising young corporate law scholars to share their research with the Delaware legal community and receive valuable feedback. Widener Law is grateful to The Delaware Counsel Group LLP and the Ruby R. Vale Foundation for co-sponsoring Myers’ visit.

Presenting a paper that he authored with Professor Charles R. Korsmo of Case Western Reserve University School of Law, Myers discussed empirical research into stockholder appraisal litigation in Delaware Chancery Court as compared to fiduciary class action suits. “Does the absence of a class action remedy mean more meritorious claims?” Myers asked of the central question that he hoped to address with the research.

Myers pointed out that the typical academic treatment of the appraisal remedy is to dismiss it as ineffective and therefore rarely used.  He countered that perception with statistics indicating substantial and increasing use of the remedy, especially among sophisticated institutional investors.  He then offered a detailed analysis and comparison between stockholder appraisal claims and traditional fiduciary class action claims brought in the Delaware Court of Chancery between 2004 and 2012. He noted that deal size seemed to be the most important variable in explaining when fiduciary class actions are initiated, with such class actions tending to target larger deals (and a commensurately greater prospect of settlement leverage), whereas the incidence of stockholder appraisal petitions correlated most strongly with deals that involved lower than expected premiums, and appeared to be uncorrelated to deal size. The implication of this research, as Professor Myers explained it, is that appraisal litigation appears to be driven by the merits from the standpoint of stockholders, while fiduciary duty class actions appear to be driven more by the fee motivations of plaintiffs’ counsel rather than the underlying merits of the claims.

These statistical observations, according to Professor Myers, are consistent with the differences in structure between appraisal actions and fiduciary duty class actions.  First, an appraisal plaintiff typically has a substantial stake in action as compared to the representative plaintiff in a fiduciary duty class action.  Second, the class of plaintiffs in a fiduciary action includes all stockholders, while an appraisal action consists only of stockholders who affirmatively elect to pursue the remedy.  Finally, fiduciary actions offer a variety of equitable remedies, and permit settlements for non-financial consideration (like supplemental disclosure), while an appraisal claim is limited to monetary compensation.  As a result of these features, appraisal litigation may tend to be relied upon only when there is a significant prospect of financial recovery, and lawyer-driven suits and settlements are less likely to occur than may be the case with fiduciary duty class actions.

Court of Chancery Considers Whether a Corporation’s Knowledge in a Laches Inquiry Bars a Derivative Suit

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In its opinion last week in Microsoft Corporation v. Amphus, Inc., the Court of Chancery considered whether corporation’s knowledge in a laches inquiry can bar a plaintiff’s derivative suit under the theory that if laches bars the corporation from bringing a claim, then derivative plaintiffs should also be barred as well because they should not be in a better position than the corporation in prosecuting the corporation’s claim.  The Court in Amphus answered the question in the negative, but cracked the door open for reconsideration.

In this case, between 1999 and 2000, the defendant director restructured his corporation, so that the corporation’s assets spun off into four new subsidiaries.  These four subs were sprinkled with directors also on the board of the parent corporation.  The plaintiff alleges that the restructuring was a scheme by which the defendant director obtained a larger financial stake in valuable intellectual property, although the fledgling corporation was in need of capital.

Although the events giving rise to the litigation occurred over a decade ago, the plaintiff argued the three-year limitation on the breach of fiduciary duty claim should be tolled “under the doctrines of fraudulent concealment and equitable tolling.”

A plaintiff asserting fraudulent concealment must allege an “act of artifice by the defendant that either prevented the plaintiff from gaining material facts or lead the plaintiff away from the truth.”  Under the doctrine of equitable tolling, “the statute of limitations is tolled for claims of wrongful self-dealing, even in the absence of actual fraudulent concealment, where a plaintiff reasonably relies on the competence and good faith of a fiduciary.”  Even if the limitation period is tolled under either of these doctrines, the period is tolled only until the plaintiff has inquiry notice of their cause of action.

The defendant, on the other hand, argued that the corporation was on inquiry notice in 2000 and failed to bring an action, thus the derivative plaintiff’s claim is time-barred.  The Court then considered the relevance of the corporation’s knowledge.  The defendant asserted that the derivative plaintiff’s complaint is addressing harms suffered by the corporation, and, if the corporation had actual or inquiry notice of the harm, then it had a responsibility to take action to protect its rights.  A derivative plaintiff’s right to bring an action on behalf of the corporation, as the defendant argued, “should be no greater than the corporation’s right to pursue the claim directly.”

In response to this argument, the Court stated:

Although [the defendant’s] argument is intuitively appealing, [the defendant] has not cited any cases that supported its position that in a derivative suit, the nominal defendant company’s knowledge is relevant in determining whether there was inquiry notice.  For purposes of this case, in determining whether [the plaintiff’s] claims are time-barred, I have focused on whether [the plaintiff], and not [the corporation], had actual or inquiry notice of [the director’s] wrongdoing.

But the Court, in a footnote, signaled that the defendant’s knowledge could be “relevant in a laches inquiry in a derivative suit.”  It noted that the defendants had several “interlocking directors,” so it is possible that knowledge was imputed between the defendant and its subsidiaries.  However, the Court found that the defendants in this case did not point to any facts that indicated the directors had any knowledge about the challenged transactions.  Therefore the Court found that at the motion to dismiss phase it would be inappropriate to presume the defendant’s knowledge, but it did leave open the possibility of different result once a “factual record is created through discovery.”

The Court’s opinion nudges the defendants to raise their laches defense again after the record is more fully developed through discovery.  However, in this case should the Court accept defendants’ argument?  Is it possible that the corporate defendant’s knowledge bars a derivative action?  Perhaps the key question is whether the corporation with such knowledge was meaningfully able to pursue the claim, or whether the corporation was under the control of the alleged wrongdoers and thus effectively unable to bring the claim.  If the former circumstance were found to be the case, there is at least a reasonable argument that application of the equitable tolling doctrine would be inappropriate, and the corporation’s claim – and the ability to pursue it derivatively – should be time-barred.

Deal Price as Cap on Fair Value: The Saga Continues

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Vice Chancellor Glasscock’s opinion yesterday in Huff v. CKx is an interesting development in appraisal case law. Like many appraisal opinions, Huff reflects a persistent frustration with the (euphemistically speaking) indeterminacy of the valuation exercise, and a tendency to want to rely on the results of actual market transactions – in this case, the actual merger price.

The appraisal proceeding in Huff arose out of an acquisition resulting from what the court found to be a reasonable, arm’s length auction process. The Vice Chancellor considered but rejected petitioners’ effort to disregard the result of the auction on the theory that it proceeded on a suboptimal basis (i.e., didn’t use a Vickrey auction approach, in which the price offered in the second highest bid in a sealed bid competition is selected). Accepting the auction result as a reasonable indicator of maximum fair value, and finding comparable company and discounted cash flow analyses unreliable in the circumstances,* the Vice Chancellor instructed the parties to submit evidence regarding the extent to which the merger price impounded synergistic value that should be subtracted in order to arrive at the statutorily-mandated determination of “fair value.”

In adopting this approach, the Vice Chancellor candidly acknowledged direction from the Delaware Supreme Court in Golden Telecom (11 A.3d 214 (2010)) that the merger price resulting from even a full and fair auction cannot place a presumptive upper limit on “fair value.” Indeed, in some post-Golden cases, such as 3M Cogent, the Court of Chancery has been reluctant to rely on sale process results in lieu of strong evidence of going concern value. As Vice Chancellor Glasscock reads Golden Telecom, however, the Supreme Court has by no means denied to the Court of Chancery the ability to consider the merger price as evidence of value, where other indicia of value are found to be unreliable – or perhaps even along with such other indicia, even when reliable. To adopt a rule precluding such consideration of the merger price would be just as inconsistent with the flexibility contemplated by the statute as the presumption rejected in Golden Telecom.

*The primary uncertainty in the DCF analyses presented at trial was the inability to predict, within any reasonable tolerance, licensing revenues associated with the once (but perhaps not future) hit show “American Idol.”

THE CONTRACTUAL DUTY OF “GOOD FAITH” – AN UNRESOLVABLE ENIGMA IN THE ABO WORLD

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CJ Steele

Chief Justice Myron T. Steele

The inaugural Ruby R. Vale Distinguished Speaker Series, held on October 28, featured Chief Justice Myron T. Steele of the Delaware Supreme Court.  Chief Justice Steele lectured on what he characterized as an unresolvable issue within Alternative Business Organizations (“ABO”) – the contractual duty of “good faith” in LLC and limited partnership agreements.

The rapid growth of ABOs since 2003 has made this a critical topic in Delaware law.  Between 2003 and 2013 there has been an 81% increase in business organizations chartered in Delaware.  Remarkably, although there has been such a dramatic increase in chartered businesses, Delaware corporations are down 8%. That decline has been offset, however, by a 174% increase in ABO’s.  Facing a tidal wave of newly formed ABOs, Chief Justice Steele opined that transactional lawyers have the heavy burden to prevent unnecessary litigation.  As he recommended, lawyers need to clearly define the fiduciary duties of members and managers, if the agreements don’t eliminate those duties.  The Chief Justice warned attorneys that if a court cannot ascertain the intent of the parties at the time the agreement was made, then the meaning of the terms would be left to the “fiat” of the court.

The lecture then turned to the Delaware Limited Liability Company Act and the “maximum effect to the principle of freedom of contract” that is to be given to LLC agreements.  To this end, Chief Justice Steele discussed the difficulty that courts have in promoting this principle if the LLC agreement’s terms are not explicitly defined.  Since that statute permits the the LLC agreement to expand, restrict, or eliminate a member or manager’s fiduciary duties as long as it does not eliminate the implied covenant of good faith and fair dealing, the terms of a member or manager’s fiduciary duties must be clear.  He then asked a rhetorical question: should a judge impose an equitable doctrine to decide a dispute within the LLC, or should the judge look solely to the terms of the contract?

Of particular concern to the Chief Justice was the definition of good faith in company agreements.  The Chief Justice reviewed the history of Delaware’s jurisprudence on implied good faith and fair dealing.  He acknowledged the unsettled jurisprudence that the bench and bar have continued to wrestle with since the 1960’s.  After acknowledging that the recent addition of 18 Del. C. § 1104 establishes that the rules of fiduciary duties apply by default, the Chief Justice puzzled over the archaic term within the statute, “the law merchant.”

Tying together the struggle to define good faith and fair dealing for over 50 years and the attempts by the General Assembly to provide a framework for guidance within ABOs, Chief Justice Steele turned to the case law addressing the “Gordian knot” of provisions of ABO agreements that attempt to define or limit the role of good faith.  Case law has focused on safe harbor provisions, where Delaware courts have struggled to determine the parties’ intent.  Recent Supreme Court cases have found good faith provisions are failing to provide for an objective or subjective standard when reviewing manager conduct.  Moreover, safe harbor provisions conflict with other fiduciary duties within the agreement causing confusion as what standard applies to particular manager actions.

To round out his message, Chief Justice Steele reminded the audience that he his retiring from the bench, so now it is the bar’s responsibility to navigate the murky waters.  Essentially, transactional attorneys have the burden to prevent opportunistic litigators from invoking ambiguous contractual good faith provisions.

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Randy MacTough

J.D. Candidate, Class of 2014

Follow-Up on Exclusive Forum Bylaw Provisions

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Supplementing the previous post on this page, Broc Romanek’s blog today reports an interesting survey about corporate plans with regard to the adoption of exclusive forum by law provisions:

Ahead of the news that the case voluntarily dismissed on appeal (see this blog), I ran a survey on what companies are doing pending news of an appeal in the area of exclusive forum by-laws. Here are the results:

1. In light of Chancellor Strine’s opinion in Boilermakers vs. Chevron, should Delaware corporations:
– Adopt a forum selection bylaw soon – 53%
– Defer considering adoption of a forum selection bylaw until the Delaware Supreme Court rules on the issue – 46%
– Never adopt a forum selection bylaw – 1%

2. Does your answer above change if the company is not incorporated in Delaware:
– Yes – 41%
– No – 29%
– I don’t know – 30%

The indication that so many firms (46%) appear to wish to await a determination by the Delaware Supreme Court corroborates the concern I previously expressed about the effect of the dismissal of the FedEx/Chevron appeal.  Separately, though, Ted Mirvis of Wachtell Lipton takes a more optimistic/aggressive view of the matter in a blog entry today.  He writes that “[a]ffirmance by the Supreme Court was widely expected. That would have been a welcome answer to those who still harbor doubt on the issue. The plaintiffs’ decision to dismiss their appeal only underscores the incontestability of the Chancellor’s ruling.”