Category Archives: News

Visiting Scholar Discusses Stockholder Appraisal in Delaware

“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

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

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

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.

__________________________________________________________________________________________

Randy MacTough

J.D. Candidate, Class of 2014

Follow-Up on Exclusive Forum Bylaw Provisions

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.”

FedEx/Chevron Appeal Voluntarily Dismissed: Smart But Problematic Tactical Move

I woke up this morning to news from the ever-faithful and thorough Chancery Daily that the plaintiffs in the FedEx/Chevron exclusive forum provision litigation have voluntarily dismissed their appeal of Chancellor Strine’s June 25, 2013 opinion generally validating forum selection bylaw provisions.

Plaintiffs’ counsel could hardly have made a more tactically intelligent move. As persuasive as Chancellor Strine’s opinion is – most people I talk to in Delaware believe that it was a shoe-in for affirmance – taking away the possibility of an endorsing opinion from the Delaware Supreme Court leaves at least a residual crack of daylight for plaintiffs to argue, in cases brought outside of Delaware, that exclusive forum bylaw provisions are generally unenforceable. That crack of daylight can only assist plaintiffs’ counsel who, for tactical reasons, would rather not litigate class or derivative claims in Delaware due to a sense that at least in some cases those claims would have settlement value that they wouldn’t have if brought in Delaware.

As you might guess, I view the dismissal of the appeal with considerable disappointment. I was hoping for and expecting a strong affirmance of the Chancellor’s ruling. Moreover, I expect that other plaintiffs’ counsel will learn a lesson from the FedEx/Chevron plaintiffs and make defendants invoke exclusive forum bylaws in jurisdictions outside of Delaware, where the courts may be less sympathetic to them.

Canmore Consultants Ltd., et al. v. L.O.M. Medical International, Inc.

Canmore Consultants Ltd., et al. v. L.O.M. Medical International, Inc., 2013 WL 5274380 (Del. Ch. Sept. 19, 2013)

This case presents an issue of first impression.  Plaintiffs filed suit under Section 223(c) of the DGCL, an infrequently litigated statute, seeking a court-ordered stockholders’ meeting to elect directors to fill three vacancies on the board of directors of L.O.M. Medical International, Inc. (the “Company”).   Section 223(c) provides in pertinent part:

If, at the time of filling any vacancy or newly created directorship, the directors then in office shall constitute less than a majority of the whole board (as constituted immediately prior to any such increase), the Court of Chancery may, upon application of any stockholder or stockholders holding at least 10 percent of the voting stock at the time outstanding having the right to vote for such directors, summarily order an election to be held to fill any such vacancies or newly created directorships, or to replace the directors chosen by the directors then in office as aforesaid, which election shall be governed by §211 or §215 of this title as far as applicable.

The vacancies that triggered the statute in this case resulted from the resignation of three of the Company’s five directors in May and June 2013.  Those vacancies were filled by appointments made by the two directors remaining on the board following the three resignations.

The Court framed the issue before it, stating:

The statute commits the decision whether to grant a petition under Section 223(c) to the discretion of the Court, but is silent as to how that discretion is to be exercised, presenting a simple but until now unanswered question: which party bears the burden of persuasion under Section 223(c)?

The Court concluded that it is the plaintiff’s burden to demonstrate that a weighing of the equities supports granting a stockholder meeting under Section 223(c).  Although there are no written decisions interpreting Section 223(c) and very few interpreting its predecessor statute, the Court explained that it views Section 223(c) as “providing only a limited exception to Section 223(a)’s grant of director authority to fill board vacancies.”  Plaintiffs argued that Section 223(c) created a presumption in favor of ordering a new election and that because they had met the statutory requirements of Section 223(c), the election should summarily be ordered without further analysis.  The Court disagreed, noting that such a presumption is not reflected in the statute’s language and that it is not enough to simply meet the statutory standing requirements.

In determining the extent of its discretion (the Court noted that the statute is permissive but “does not point to any factors as controlling in this exercise of discretion”), the Court analyzed Section 223(c) in conjunction with Section 223(a), which provides: “[u]nless otherwise provided in the certificate of incorporation or bylaws: (1) Vacancies and newly created directorships resulting from any increase in the authorized number of directors elected by all of the stockholders having the right to vote as a single class may be filled by a majority of the directors then in office, although less than a quorum, or by a sole remaining director . . .  ”

The Court looked to the purpose of Section 223(c), which it described as:

Limit[ing] Section 223(a)’s grant of director authority by allowing Court intervention to prevent a minority of elected directors from appointing a majority of the board, where the holders of at least ten percent of the shares outstanding request a vote, and where the equities in favor of postponing such a vote until the next annual meeting do not outweigh the interests of the stockholders in an immediate exercise of their voting franchise.

The Court noted that its determination that Section 223(c) provides a limited exception to directors’ ability to fill vacancies is supported by the language of Section 223(a) permitting directors to fill board vacancies where doing so is not prohibited by a company’s certificate of incorporation or bylaws.

The Court also looked to the only written decision granting an election under Section 223(c)’s predecessor statute — McWhirter v. Washington Royalties Company, which was decided in 1930 — for guidance in determining the extent of the Court’s discretion under Section 223(c).  In McWhirter, four directors resigned from a seven-member board of directors, leaving three remaining vacancies.  The resignations prompted 43% of the company’s stockholders to petition the Court for a new election to fill the vacancies.  The McWhirter Court concluded that the fact that 43% of stockholders supported the petition (well over the 10% required by Section 223(c)) was prima facie evidence that ordering a new election was appropriate even though the company had held an election three months prior.  The Court also discussed Prickett v. American Steel & Pump Corporation, a 1969 case in which the Court ordered an election under Section 223(c), however, no annual meeting had been held the previous year in violation of Section 211(b) of the DGCL.  Neither McWhirter nor Prickett were particularly instructive as the Plaintiffs in this case did not constitute such a large group as in McWhirter and the Company has held an election in the past year.

In weighing the equities, the Court focused on the specific facts of this case.  In particular, the Court noted that the Company just held an election in March 2013, which the Court had ordered in a prior lawsuit involving some of the same parties brought pursuant to Section 225 of the DGCL.  The Court also explained that it had permitted the Company to accept a loan of $200,000 from Plaintiff Woloschuk (formerly a director of the Company before the March 2013 election) based on representations that the Company lacked funds to pay for the March 2013 stockholder meeting.  Those funds were subsequently used to pay legal fees while certain expenses associated with the March 2013 election were left unpaid.  The Court also recognized that two of the plaintiffs — Woloschuk and Roteliuk — had been part of the incumbent board that was defeated at the March 2013 election.  The Court further emphasized that Plaintiffs’ standing to bring this action under Section 223(c) “arises from simple fortuity” due to the 4 a.m. resignation of the third director, creating the third vacancy, on June 13, 2013, one day before the filing of the complaint on June 14, 2013.

The Court concluded that the main issue with ordering another stockholder meeting was that the Company lacks the necessary funds to hold another meeting.  The Court explained that there was no reason to believe that the Company could raise additional funds to both pay its debts and pay for another meeting, nor was there any persuasive equitable reason to conclude that stockholder interests are not protected by the current board.  The recent rejection of the slate of directors associated with the plaintiffs at the March 2013 meeting was also a reason for the Court’s final decision.

AUTHORS

The authors of this article are attorneys at Cousins, Chipman & Brown, LLP in Wilmington, Delaware.

Stephanie S. Habelow, habelow@ccbllp.com

Paul D. Brown, brown@ccbllpc.om

Joseph B. Cicero, cicero@ccbllpc.com

Proxy Access Proposals in 2013 – Anybody Out There?

What a difference three years can make! In 2010 proxy access was the hot issue in corporate governance circles: investors and legal practitioners eagerly awaited the outcome of the SEC’s rulemaking on that subject, and carefully watched the ultimately successful legal challenge to the rules that were promulgated. And even when those rules were largely invalidated, there was rampant speculation about the prospect of the use of private ordering to adopt proxy access bylaws through shareholder proposals under revised Rule 14a-8.

Just three years later, however, the world seems to have passed proxy access by. Suggestions that a low frequency of access proposals in 2012 would be followed by increasing attention to the topic in 2013 didn’t pan out: in fact, there were even fewer proxy access shareholder proposals in 2013 than in 2012 – a total of ten, if my count is right, compared to twelve in 2012.

So I present the 2013 statistics here without great enthusiasm or expectation of intense interest on anyone’s part. In part, that’s because there’s a much more comprehensive, nicely searchable resource for the outcomes of votes on shareholder proposals, prepared by Proxy Monitor, sponsored by the Manhattan Institute’s Center for Legal Policy. And those folks spare you any editorial comment, thanks.

And with so little data to work with, there’s not much profound to say about the results of the voting on 2013’s proxy access proposal. As in 2012, though, proposals that call for much more liberal proxy access than the 3%/3 year formula adopted by the SEC don’t do very well: with one exception, they didn’t achieve over 20% of even the votes cast, let alone of shares present or outstanding; most received below 10%; and the only proposal of this sort that did at all “well” was at Staples, where a 1%/1 year proposal garnered 33% of the votes cast.

Not surprisingly, sponsorship by management tends to help, a lot: with management support at HP and Chesapeake Energy, proxy access bylaws received support of over 97% of the votes cast. At Chesapeake, however, even that level of support wasn’t enough: the proposal required approval by two-thirds of the outstanding shares, and only 60% of the outstanding shares supported the measure.

The “success” stories for proxy access this year were at Verizon and CenturyLink, where precatory 3%/3-year proposals received a majority of the votes cast (although less than a majority of the shares outstanding). Whether and how the boards of directors of those companies respond to these votes remains to be seen. Also unknown at this point is when, if ever, any shareholder will actually use proxy access rights once a bylaw is adopted (as occurred at HP (Section 2.2(h) of its bylaws) and Western Union (Article II, Section 8(c) of its bylaws as of May 30, 2013).

MFW: One For the Casebooks

Doing a post on Chancellor Strine’s opinion in MFW Shareholders Litigation, granting summary judgment to the defendants in a suit challenging a merger with a controlling stockholder, induces serious blogger’s guilt. It is nothing short of presumptuous to try to say anything analytical about an opinion just days after it was issued, when the opinion itself is so obviously the product of assiduous care in analyzing precedent and doctrine.

But kibitzing is an academic’s business, so here goes. First, a note to my fellow corporate law professors: if you haven’t already done so, you might as well read this opinion now. You’re going to be teaching it next year, and perhaps for quite a while after, or at least you should. There’s nothing surprising about the proposition that Leo Strine has written an opinion worth reading, but for my money this is one of his – and therefore one of the – best corporate opinions ever, on a par with or perhaps even better than my previous favorite, Pure Resources.

Several aspects of MFW make it a great opinion. First, its persuasiveness derives in large part from its modesty. (Hat tip to former Chancellor William T. Allen for teaching me the persuasive value of modesty). It is (probably quite intentionally) devoid of “because I said so” assertions. At practically every turn, the opinion acknowledges the debatability of its conclusions.

Second, the MFW opinion is a marvelous lesson in common law jurisprudence and, in particular, the meaning of the term “dictum.” Inevitably in judicial opinions, judges provide explanations or reasoning that later factual situations reveal to be overbroad or imprecise, or both. Nothing wrong with that: it’s impossible to foresee all the ramifications of any generalized statement. The MFW opinion repeatedly exposes instances in which language about standards of review and burdens of proof strays beyond the factual boundaries of its original context. More importantly, MFW then reminds us that it behooves common law judges not to become enslaved to that language in deciding subsequent cases. Rather, they have to carefully examine the extent to which such language was actually necessary to determine the outcome of the case in which the language is expressed. Where it wasn’t, it becomes important to examine whether to extend the application of that language to a different set of facts.

Finally, MFW is extraordinary for its transparency in addressing the empirical foundation of the conclusions it draws. One notable aspect of MFW’s analysis illustrates this point, and exposes the distinct possibility that the Delaware Supreme Court will reverse the grant of summary judgment. The Chancellor’s analysis emphasizes the bipartite idea that in approving a merger with a controlling stockholder, a fully empowered, independent special committee fulfills the function served by the full board of directors in an arm’s length merger, and the informed vote of a majority of the minority stockholders fulfills the function served by the statutorily required vote of stockholders on an arm’s length merger. To reach the latter aspect of this conclusion, however, the MFW opinion analyzes at some length whether the majority of the minority vote is qualitatively equivalent to the stockholder vote on an arm’s length merger.

The question is whether the stockholder vote is any less voluntary in respect of a proposed merger with a controlling stockholder than it is in respect of a merger with a third party. To answer that question, the MFW opinion notes instances in which stockholders have voted down, or threatened to vote down, merger proposals, including the pending effort by Sprint to acquire the balance of Clearwire’s equity. The opinion also reviews the increasingly concentrated holdings of institutional investors, who presumably have a greater ability to resist merger proposals they don’t like (a phenomenon facing Michael Dell at the moment).

But whether a minority stockholder vote is as voluntary as a vote in the absence of a controller is an empirical question that may be impossible to resolve definitively in any particular case, let alone as a general proposition. Moreover, it’s a question on which the Delaware Supreme Court has spoken, repeatedly. Quoting what it had held in 1990 in Citron v. E.I. duPont de Nemours, Inc. , the Supreme Court in Kahn v. Lynch Communications explained at some length why one should conclude that the minority stockholder vote is never entirely voluntary and uncoerced:

Parent subsidiary mergers, unlike stock options, are proposed by a party that controls, and will continue to control, the corporation, whether or not the minority stockholders vote to approve or reject the transaction. The controlling stockholder relationship has the potential to influence, however subtly, the vote of [ratifying] minority stockholders in a manner that is not likely to occur in a transaction with a noncontrolling party.

Even where no coercion is intended, shareholders voting on a parent subsidiary merger might perceive that their disapproval could risk retaliation of some kind by the controlling stockholder. For example, the controlling stockholder might decide to stop dividend payments or to effect a subsequent cash out merger at a less favorable price, for which the remedy would be time consuming and costly litigation. At the very least, the potential for that perception, and its possible impact upon a shareholder vote, could never be fully eliminated. Consequently, in a merger between the corporation and its controlling stockholder–even one negotiated by disinterested, independent directors–no court could be certain whether the transaction terms fully approximate what truly independent parties would have achieved in an arm’s length negotiation. Given that uncertainty, a court might well conclude that even minority shareholders who have ratified a . . . merger need procedural protections beyond those afforded by full disclosure of all material facts. One way to provide such protections would be to adhere to the more stringent entire fairness standard of judicial review.

This, of course, is a decidedly pessimistic view of the prospect that minority stockholders will vote their convictions about the value of the controller’s merger proposal. It may be that the particular retaliatory threats identified by the Supreme Court wouldn’t apply in MFW’s situation, because, for example, the controlling stockholder had committed not to proceed with a merger unless approved by both the special committee and the majority of the minority stockholders. Nevertheless, the plain language of the Supreme Court’s assessment of minority stockholder vulnerability makes it seem almost impossible to believe that a minority stockholder vote could contribute to dispensing with the obligation of the court to evaluate the fairness of a merger with a controlling stockholder. But make no mistake: the Supreme Court’s assessment of minority stockholder voting behavior was, when first announced in Citron and later reiterated in Kahn, unsupported by any empirical or even anecdotal evidence. It was simply speculation – plausible, perhaps – about the subjective state of mind of minority stockholders.

And if the Court of Chancery accurately perceived the plaintiffs’ own position in the MFW case, the Supreme Court’s empirical assessment is not shared by the plaintiffs themselves: the Chancellor noted that “the plaintiffs themselves do not argue that minority stockholders will vote against a going private transaction because of fear of retribution … .”

But the Delaware Supreme Court must inevitably make law for all cases, not just the one shaped by the position of counsel in the case before it. It remains to be seen, then, whether the empirical assessment expressed in MFW will survive appellate consideration. If it doesn’t, and if the Supreme Court adheres to its prior empirical pronouncements, it seems quite possible that the doctrinal structure advocated in MFW, in which dual approval by an effective special committee and a majority of minority stockholders obviates the need to examine fairness, will fall away, leaving entire fairness as the continuing test for evaluating mergers with controlling stockholders. The Court of Chancery rightly notes that this view would perpetuate the unfortunate result that controllers will have no incentive to seek minority stockholder approval through a vote, and will instead follow the path of a tender offer and short form merger, which provides less protection for minority stockholders but, oddly, greater protection from judicial scrutiny.

Municipal Bankruptcy: Understanding the Limited Powers of the Judiciary

From two students at our Harrisburg campus (Julia Skinner (Class of 2013) and Corey Dietz (Class of 2014)), the following post presents some insights into uncertainty about the operation of municipal bankruptcy proceedings:

Municipalities contemplating filing for bankruptcy are met with resistance because of the fear of rogue judges taking over a city’s finances and making cuts to wherever they see fit. The deteriorating financial condition of many municipalities is bringing these fears to the forefront of the minds of city employees, officials, and citizens. Because municipal bankruptcy filings are rare, many people are uninformed about exactly how municipal bankruptcy works. Unlike individuals and business entities that file for bankruptcy, municipalities that file under chapter 9, the municipal bankruptcy chapter, maintain the freedom to control their finances and property, with judicial interference being permitted only when the municipality consents. The sometimes-stated fear of a judicial takeover of a city is far from the truth of how a chapter 9 bankruptcy works. Section 904 of the Bankruptcy Code imposes limits on the federal court to assure that powers reserved to the states are honored. The section states:

[n]otwithstanding any power of the court, unless the debtor consents or the plan so provides, the court may not, by any stay, order, or decree, in the case or otherwise, interfere with- (1) any of the political or governmental powers of the debtor; or (2) any of the property or revenues of the debtor; or (3) the debtor’s use or enjoyment of any income-producing property.

11 U.S.C. § 904. This limitation bars the possibility of rogue judges and judicial control over the city functions. The case law reinforces the concept of judicial limitations and municipal freedoms.

One of the opinions in Stockton, California’s bankruptcy case illustrates these limitations. Stockton has a population of approximately 300,000 people and on June 28, 2012, it became the largest city to ever file for bankruptcy. Stockton owes more than $350 million to bond insurers. Stockton has stopped paying some bondholders and creditors have been contesting the city’s payments to state pension fund and the California Public Employees’ Retirement System, or CalPERS. California’s Stockton can pay claim opposed by bond insurers, Reuters (Jan. 30, 2013, 7:35 PM). The retired employees of Stockton brought suit as a class action by the Association of Retired Employees of the City of Stockton (ARECOS) and 8 retirees on July 10, 2012, together with an Application for Temporary Restraining Order in order to continue the payment of the retiree health benefits. In re City of Stockton, Ca., 478 B.R. 8 (2012). The city created a new budget that reduced payments to the plaintiffs. The retirees brought suit seeking an injunction prohibiting the City from implementing the retiree health benefit reduction as part of its annual operating budget. The plaintiffs filed suit claiming that they had vested contractual rights protected by the Contracts Clause of the United States Constitution to continue the payments. Id. at 13. Judge Klein noted that “the Contracts Clause bans a state from making a law impairing the obligation of contract; it does not ban Congress from making a law impairing the obligation of contract.” Id. at 15. Therefore, the Bankruptcy Clause authorizes Congress to make such laws that would impair contracts. Specifically, § 904 forbids the court from granting such an injunction, allowing a city to control their finances without judicial interference under the Bankruptcy Clause.

Although the retirees feel that they have been wronged by having their payments reduced, § 904 prevents the court’s ability to issue an injunction whether it is fair or not. Section 904 is so comprehensive that it “functions as an anti-injunction statute- and more.” Id. at 20. In short, the § 904 limitation on the court’s authority is absolute unless a city either consents or a provision in a plan of adjustment has already been proposed. Id.

The only real remedy for the retirees is to participate in the process of formulating a plan of adjustment (a plan of adjustment is the chapter 9 equivalent to chapter 11’s plan of reorganization). According to settled bankruptcy law, Stockton may “implement interim contractual modifications before the confirmation of a chapter 9 plan of adjustment but such revisions do not, as a matter of law, become permanent unless and until made part of a confirmed plan of adjustment or otherwise voluntarily agreed.” Id. at 30. Therefore, no matter how unfair it may seem to the retirees or plaintiffs in general, the judiciary’s hands are tied under § 904.

Jefferson County, Alabama, filed the largest municipal bankruptcy measured by outstanding debt in November, 2011. The court in Jefferson County’s case applied § 904 in the same manner. Jefferson County was in a dire financial state and was seeking ways to save money. The Cooper Green Hospital operated by the county was continuously spending over budget and operating at a loss. In re Jefferson County, 484 B.R. 427, 435 (2012). The county was no longer able to fund the hospital’s deficits Id. at 434. Jefferson County decided to close the Cooper Green hospital emergency room as well as end inpatient procedures. Id. at 435. Several parties, including the city of Birmingham, employees, inpatients and the mayor, sought an injunction to prevent the county from closing the hospital. Id. at 437.

In refusing the injunction, the court discussed the powers of a municipal debtor. The court found a chapter 9 debtor retains full title over property and retains control over the properties operations. Id. at 462. The freedom of the chapter 9 debtor was incorporated in § 904 along with a restriction on the bankruptcy court’s ability to interfere with a municipal bankruptcy. Id. at 462. Without a municipal debtor’s consent a bankruptcy court may not interfere with any political or governmental powers, any of its property or revenues, or its use and enjoyment of income-producing property. Id. at 463.

In a more recent Stockton opinion the court consistently applied § 904. In In re City of Stockton, the issue was whether a Chapter 9 municipal debtor must obtain court approval under Federal Rule of Bankruptcy Procedure 9019 of any compromise or settlement the municipality makes during the course of the bankruptcy. In re City of Stockton, California, 486 B.R. 194, 195 (2013). The City of Stockton had agreed to settle a lawsuit for $55,000. Id. The capital market creditors claimed that the city must make a motion under Rule 9019 for court approval of the settlement. Id. The city’s contention was that Rule 9019 did not apply in chapter 9 cases unless the city sought court approval. Id. The court held that Rule 9019 applies to municipal bankruptcy cases only if the municipality consents to the court considering approval of a settlement or compromise. Id. at 197. However, when a chapter 9 debtor files a Rule 9019 motion to have a court approve a compromise the municipality can consent to judicial interference. Id. The court also held the city can expend its property and revenues during the chapter 9 case in any way it wants. Id. at 198. The court in this Stockton opinion maintained that the judiciary could only interfere with a municipal bankruptcy when the municipality consents to the interference.

The courts are steadfast in their interpretation of § 904 prohibiting judicial interference with a municipal bankruptcy unless the municipality consents to the interference. The fears that are prevalent among city leaders and the general public of judicial control and dominance are unfounded. Judges may not step in and control the city’s finances directly after a city has declared bankruptcy. Through § 904, Congress ensured the judiciary’s hands are tied allowing the municipality to maintain control over its property and revenues.