All posts by kmaloney

Affordable Care Act Creates Incentives for Small Businesses to Provide Health Benefits

In a blog post for the Delaware Journal of Corporate Law, DJCL Staff Member Samantha Darrow Osborne discusses how the Affordable Care Act’s recent substantial increase in individual penalties has created an incentive for small businesses to partake in offering health benefits to their employees.  She argues that small businesses that offer coverage will receive tax advantages and a generous tax credit, and will attract and retain more qualified employees.


“Adding Ethics to the Fiduciary Relationship”

Rick Alexander

This year’s second installment of the Ruby R. Vale Distinguished Speaker Series was held on February 18, 2016 and featured Frederick H. Alexander. Mr. Alexander is the Head of Legal Policy at B Lab and Counsel to Morris, Nichols, Arsht & Tunnell LLP. His lecture, “Adding Ethics to the Fiduciary Relationship,” discussed the importance of developing rules throughout the governance system that allow corporations to act in a responsible and ethical manner.

It is well established that fiduciaries manage the corporation and act on its behalf for the sole benefit of its investors. To remedy the potential agency problem that may stem from this fiduciary relationship, fiduciary duties were created to mitigate the risk of misappropriation of corporate assets. As Mr. Alexander described it, however, fiduciary duties protect only stockholder interests, while ignoring the interests of all other stakeholders in the governance system, such as employees, customers, and the community. Further, Delaware jurisprudence reinforces this notion, especially by imposing a Revlon duty on directors to perform their fiduciary duties in the service of maximizing the corporation’s sale price. Sale price thus remains the most widely accepted measurement of a corporation’s success.

This creates a “shareholder primacy” paradigm where directors’ only responsibility is to increase profits for the stockholders’ benefit. As a result, any corporate action that benefits employees, customers, or the community must first benefit stockholders to be a valid use of the corporation’s assets. The shareholder primacy paradigm creates several problems, not only for society, but also for investors. First, shareholder primacy restricts management’s ability to pursue a variety of commitments on behalf of the corporation. It is evident that any commitment entered into by the corporation will be contingent upon creating value for shareholders. This creates a trust problem within a corporation, either between the employer and its employees or between the current stockholders and future stockholders. Second, primacy causes negative externalities to be passed from one company to another, which affects universal investors’ diversified interests in the general market. These two problems unite to form the overall problem with shareholder primacy: management’s goal is to obtain as much value as possible, but that is not always the best way to measure a corporation’s worth. Instead, Mr. Alexander argued that a corporation should be measured by its shared real value created when a corporation takes on certain commitments, thereby creating trusting relationships with stakeholders other than just stockholders.

Traditionally, the Delaware General Corporation Law (“DGCL”) mandated that shareholder-elected directors manage the company carefully and loyally pursuant to their fiduciary duties and for the sole purpose of creating shareholder value. However, the DGCL now provides an option for corporations to elect to be a benefit corporation. In addition to creating value for its shareholders, a benefit corporation may also consider the interests of all stakeholders. Under DGCL § 362, a Delaware benefit corporation must operate in a “responsible and sustainable manner.” A “public benefit” is a “positive effect (or reduction of negative effects) on one or more categories of persons, entities, communities or interests (other than stockholders in their capacities as stockholders) including, but not limited to, an artistic, charitable, cultural, economic, educational, environmental, literary, medical, religious, scientific or technological nature.” Today, thirty-two states have adopted provisions allowing for the option to become a benefit corporation, thus creating a new path for investment channels to follow.

In conclusion, Mr. Alexander emphasized that there is more to be done to encourage corporations to act in a socially responsible way. Because becoming a benefit corporation is still optional, corporations should adopt a set of fiduciary laws that recognize the interests of all stakeholder values and not just stockholder interests. In addition, investors should cease seeking short-term gains and instead invest private capital in avenues that result in positive social gains that benefit all stakeholders. Overall, Mr. Alexander urged that corporations should “stop competing to take and start competing to make.”

Considerations in Implementing Country-by-Country Reporting

The OECD’s final BEPS report proposes country-by-country reporting to increase transparency with transfer pricing.  In a blog post for the Delaware Journal of Corporate Law, DJCL Staff Member John Brady explains that country-by-country reporting leaves some unanswered questions about how these reports will be exchanged with foreign jurisdictions while maintaining adequate protections to safeguard this information.  He argues that the U.S. should implement an objective privacy standard with specific safeguards prior to implementing information exchanges.


Delaware Supreme Court Finds Third-Party Advisor Liable for the Board’s Breach

In RBC Capital Markets, LLC v. Jervis, the Delaware Supreme Court held that a third-party financial advisor was liable for aiding and abetting a Board of Directors’ breach of fiduciary duties.  In a blog post written for the Delaware Journal of Corporate Law, DJCL staff member Michael Laukaitis explains that to be found liable for such conduct, third-party advisors must knowingly aid the board’s breach and may protect themselves by fully disclosing any possible conflicts to the board.


Fine-Tuning Revlon: The Consequence of Fair and Fully Informed Stockholder Votes

The recent Delaware Supreme Court decision of Corwin v. KKR Financial Holdings, LLC held that in the event of a fair and fully informed stockholder vote, a court will apply the business judgment standard instead of Revlon‘s increased scrutiny.  In a blog post written for the Delaware Journal of Corporate Law, DJCL staff member Nicholas Picollelli, Jr.  explains that because a conflict-free vote puts stockholders in the best position to evaluate a proposed transaction, heightened Revlon scrutiny is unnecessary.


The U.S. Government and Corinthian Colleges, Inc.: Picking Winners and Losers

Corinthian Colleges, Inc., a for-profit career-college, closed its doors amid allegations of predatory student loan practices and fraud and misrepresentation surrounding graduation rates and job placement statistics.  In a blog post written for the Delaware Journal of Corporate Law, DJCL staff member Chris Kephart describes the unprecedented decision of the federal government to facilitate the forgiveness of close to $1 billion in public and private student loans, by negotiation with the holder of the private student loans and directly providing debt relief for students who took federal student loans to attend Corinthian.


Director Independence Analysis Refined

In a rare reversal of a Chancery Court decision, the Delaware Supreme Court revived a pension fund’s derivative complaint, holding that demand on the board would have been futile.  In a blog post written for the Delaware Journal of Corporate Law, DJCL External Managing Editor Sabrina Hendershot discusses Delaware County Employees Retirement Fund v. Sanchez, where the Court held that a director’s quarter-century friendship and significant business ties supported a pleading-stage inference that the director lacked independence.  Though, this opinion was decided in the context of the defendants’ motion to dismiss, and it is thus still unknown how the Court of Chancery will hold on remand with a more developed record, this opinion serves as an important reminder for boards to be mindful of personal relationships in assessing director independence.


The 31st Annual Francis G. Pileggi Distinguished Lecture in Law: “Shareholder Activism: the Triumph of Delaware’s Board-Centered Model and the New Role for the Board of Directors”

GordonOn October16, 2015, the Delaware Journal of Corporate Law presented the 31st Annual Francis G. Pileggi Distinguished Lecture in Law.  This year’s lecture featured Professor Jeffrey N. Gordon, the Richard Paul Richman Professor of Law at Columbia Law School.

Professor Gordon’s lecture focused on the transition in Delaware law from the hostile takeovers in the 1980s to the current role of the activist shareholder.  Specifically, Professor Gordon argued that Delaware jurisprudence should celebrate shareholder activism because it focuses governance attention on the board of directors, the leading objective of Delaware’s corporate and takeover law.  In turn, courts should reject the poison pill as a managerial defense against an activist voting campaign. Instead, Professor Gordon contends that the focus should be on broadening the role of directors to become credible managers and defenders of the firm’s business strategy.  According to Professor Gordon, this is the next step in the evolution of directors’ role in the public firm.

Professor Gordon articulated three claims that formed the foundation of his lecture.  First, the current variety of shareholder activism reflects triumph of the Delaware board-centric model and reinforces the importance of director elections.  Second, a reorganization of the board is in order to include more full-time directors, rather than directors whose part-time role requires them to be guided by stock price performance.  The current model, which is made up of mostly part-time directors who merely monitor, but not manage, the firm, is simply an experiment of organizational design that should be reconsidered.  Third, the purported short-termism associated with activist shareholders is a symptom, not a cause, of most directors’ inability to closely monitor their firm’s activities.  As such, restructuring may be necessary to ensure that directors take a “deeper dive” into the firm’s operations, which would help Delaware’s board-centric model continue to thrive.

In questions following the talk, some expressed concern with Professor Gordon’s suggestion to overhaul the current board model.  One question posed the problem of how to avoid having more engaged, full-time directors become essentially members of management and therefore less able to perform a monitoring function.  As Justice Randy J. Holland of the Supreme Court of Delaware has explained, “For the last twenty-five years, the Delaware courts have emphasized the importance of independent directors in safeguarding the interests of shareholders by preserving the integrity of the corporate governance process.”  Another questioner noted the irony that in its judicial opinions in the 1980s and 1990s, the Delaware courts emphasized both the importance of independent/outside directors, who are constrained to rely on stock market prices as a measure of corporate success, while at the same time (in cases like Smith v. VanGorkom) calling into question undue reliance on market prices as a measure of firm value. After a brief discussion, Professor Gordon concluded, “We should not regard governance forms as frozen, but in constant need in reorganization” as time demands.  According to Professor Gordon, Delaware courts should embrace the current trend of shareholder activism because it reinforces the Delaware board-centric model of corporate governance.

Professor Gordon’s Pileggi Lecture will be discussed in great detail in his forthcoming article that will be published in Volume 41 of the Delaware Journal of Corporate Law.

Bargaining Away Fiduciary Duty: Considering Partnership Agreements After Kinder Morgan

The recent Dole and Kinder Morgan Court of Chancery opinions highlight the differing roles of fiduciary duties in corporations and limited partnerships.  In a blog post written for the Delaware Journal of Corporate Law, DJCL staff member Donald Huddler  summarizes the basic fiduciary duties of corporate fiduciaries and limited partnership fiduciaries and considers how the facts in Dole would be treated if they were governed by the terms of the Kinder Morgan partnership agreement, thus probing the outer limits of permissible conduct under limited partnership agreements.


“Delaware Fiduciary Duties: Case Dispositive Pre-Trial Motions”

JusticeHolland-RobesThis year’s first installment of the Ruby R. Vale Distinguished Speaker Series was held on September 29, 2015, and featured Justice Randy J. Holland of the Supreme Court of Delaware. Justice Holland’s lecture, “Delaware Fiduciary Duties: Case Dispositive Pre-Trial Motions,” discussed central Delaware decisions establishing how independent directors can prevail on a motion to dismiss or motion for summary judgment, thereby avoiding costly and protracted litigation.

Justice Holland enumerated three variables of a shareholder action that determine the success of directors’ pre-trial motions: the fiduciary duty allegedly breached, the nature of the suit, and the standard of judicial review. As Justice Holland described it, corporate directors owe a triad of fiduciary duties to the corporation and its shareholders: care, loyalty, and good faith. If any of these duties are breached, shareholders may challenge the directors’ actions by way of a direct or derivative suit, which, upon judicial review, will be afforded the deference of the business judgment rule or reviewed under the entire fairness doctrine. Under Aronson v. Lewis, a shareholder plaintiff must present particularized facts contending that a majority of the directors were interested and lacked independence or that the challenged transaction was not the product of a valid business judgment. Justice Holland thus emphasized that if a majority of disinterested directors approves the board’s decision, the defendant corporation will be given the deference of the business judgment rule, and its motion to dismiss will be granted.

Conversely, if the shareholder plaintiff successfully overcomes the business judgment rule’s strong presumption that the board’s action was undertaken with due care, loyalty, and good faith, the court reviews the transaction under the entire fairness doctrine, which requires that the board decision be supported by proof of fair dealing and fair price. The board’s decision in Smith v. Van Gorkom was reviewed under the business judgment rule. Because the directors breached their fiduciary duty of care, the Delaware Supreme Court held that the directors were personally liable. Although holding directors personally liable for such a breach would most certainly discourage companies from incorporating in Delaware, Justice Holland opined that Van Gorkom is but one case of many that illustrates the Delaware Supreme Court consistently remains “above the fray.”

Van Gorkom‘s holding prompted the legislature to swiftly adopt Delaware General Corporation Law (“DGCL”) §102(b)(7), which allows Delaware companies, with shareholder approval, to adopt charter amendments to exculpate directors from personal liability for failure to exercise due care (i.e., acting with gross negligence). Virtually all Delaware corporations have enacted this amendment. While a complaint seeking injunctive relief that alleges nothing more than gross negligence may go forward, such a complaint seeking only monetary damages will be dismissed. To survive dismissal, the complaint must implicate a breach of loyalty or good faith, such as in In re Walt Disney Company Derivative Litigation, where defendants’ motion to dismiss and motion for summary judgment were denied. Justice Holland’s advice to directors was forthright: follow the “best practice” of using special committees to establish a fair dealing price and avoid the fate met by the directors in Disney and Van Gorkom.

The likelihood of defendants’ success at the pre-trial stage is “materially advanced” if the board uses an independent committee to inform its decision. Under Kahn v. Lynch, an independent committee’s decision, when reviewed under the entire fairness doctrine, causes the burden to shift to the shareholders to show there was an unfair deal and unfair price, but the directors’ decision does not automatically receive business judgment rule deference. Alternatively, under In re MFW Shareholders Litigation, directors who condition action on approval by an independent committee and a majority-of-the-minority vote with full disclosure are awarded the great deference of the business judgment rule.

Justice Holland concluded by summarizing the Delaware Supreme Court’s message to shareholders and independent directors over the past decade. The Court recommends that shareholders to “use the tools at hand” to ensure their case survives dismissal, such as filing a DGCL §220 demand to inspect a corporation’s books and records, and instructs that directors make independent decisions and uphold their fiduciary duties. The Delaware Supreme Court has long recognized that shareholders have legitimate expectations that directors will act with care, loyalty, and good faith, and that directors have an equally legitimate expectation that they will not be forced to endure prolonged meritless lawsuits brought by shareholders. Delaware has grappled with these conflicting expectations for decades, and has developed a stable and predictable body of law that informs directors how to avoid protracted litigation, which includes the requisite showings of successful pre-trial motions.