Category Archives: News

The “Outer Reaches” of Allowable Conduct? Or “You Ain’t Seen Nuthin’ Yet?”

Lawrence A. Hamermesh, Ruby R. Vale Professor of Corporate and Business Law
January 17, 2012

Two ostensibly unrelated events in the last two weeks implicate deep questions about the basic role of private ordering and regulation in relation to publicly traded equity securities.

The first of these events was Vice Chancellor John Noble’s opinion in Gerber v. Enterprise Products Holdings, LLC, et al (Del. Ch. Jan. 6, 2012). The Delaware Corporation & Commercial Litigation Blog has a nice summary of the case here, but the nub of the opinion was its determination to dismiss a claims that a 2009 sale of assets to an affiliated person violated the general partner’s fiduciary duties and that a merger subsequently implemented by the general partner improperly failed to consider the value of that pre-existing derivative claim against the general partner. The reasoning underlying that dismissal was that (i) the asset sale and the merger each received one form of what the limited partnership agreement defined as “Special Approval” (approval by a special committee of independent directors), thereby eliminating any claim of breach of fiduciary duty; and (ii) the residual claim that the general partner violated its implied obligation of good faith and fair dealing was precluded by the provision in the limited partnership agreement that the general partner’s “good faith is conclusively presumed where the general partner relief on the fairness opinion of an independent consultant.” In the case at hand, the general partner had obtained and reasonably relied on fairness opinions from Morgan Stanley.

The court’s opinion seems to chafe, to put it gently, at the contractual and legal strictures imposed by the limited partnership agreement:

The facts of this case take the reader and the writer to the outer reaches of conduct allowable under 6 Del. C. § 17-1101. It is easy to be troubled by the allegations. Alternate entity legislation reflects the Legislature’s decision to allow such ventures to be governed without the traditional fiduciary duties, if that is what the partnership agreement or other governing document provides for, and allows conduct that, in a different context, would be sanctioned. Ultimately, the investor, who is charged with having assessed and accepted the risks of putting his money in an entity without the comfort afforded by fiduciary duties, is left with contractual protections, either those that are expressed or those that are within the implied covenant of good faith and fair dealing. Here, those protections were minimal and did not provide EPE’s public investors with anything resembling the protections available at common law.

As the Vice Chancellor expressed in an extended footnote, minimal contractual protection for public investors may potentially result in one of two consequences – discounted trading of the affected securities, or regulatory intervention:

If the protection provided by Delaware law is scant, then the LP units of these partnerships might trade at a discount or another governmental entity might step in and provide more protection to the public investors in these partnerships. Those issues, however, are not ones that this Court need or should address. The General Assembly has decided that this Court has only a limited role in protecting the investors of publicly traded limited partnerships that take full advantage of 6 Del. C. § 17-1101(d), and that is a role this Court must accept.

Meanwhile, and in a superficially very different context, the Carlyle Group, L.P. filed a January 10, 2012 amendment to its Form S-1 registering a public offering of its limited partnership units. Among other things, this amendment disclosed that the Carlyle limited partnership agreement would contain a fairly unusual provision governing the resolution of disputes involving the limited partnership’s internal affairs. In broad outline, it would provide that all limited partners would irrevocably agree that disputes relating to the limited partnership – including claims of breach of fiduciary duty, breach of the partnership agreement, and violation of the federal securities laws – will be subject to arbitration, and not be litigable, and would be arbitrated before three arbitrators in Wilmington, Delaware [wait, it gets better!] who are U.S. lawyers, retired judges, or [wait for it … ]

U.S. law professors [Law professors in Delaware? Can it get any better than this??].

Would a provision like this be valid if it were in a corporation’s certificate of incorporation? Not sure on that one – but I tend to think that a charter provision selecting the Delaware courts as an exclusive forum for hearing controversies involving internal corporate affairs is probably effective, at least if it’s included in an original (pre-IPO) certificate of incorporation. If that’s right, then it should be even easier to validate such an exclusive forum provision contained in a pre-IPO limited partnership agreement. And would an arbitration selection provision be any less effective? If one believes that organizational governing documents are contracts like all others, even when applicable to (“entered into by”) public investors, the answer has to be no, so at least for non-corporate entities a provision mandating arbitration would be effective.

Is this disturbing?  That depends, I suppose, on whether you believe that, as Vice Chancellor Noble put it, the limited partnership interests (or shares of stock, if we were dealing with a corporation) would “trade at a discount” reflecting a meaningful market assessment of the value (negative, if one presupposes a discount) of the dispute resolution provision.  If one were confident that the market – including the IPO market – would accurately price such provisions (whatever the word “accurately” means), perhaps there’s no real cause for concern: people will get what they pay for. On that view of things, it may not even matter that some investors are individually unaware of what dispute resolution or other rights they may be forgoing. On that view, perhaps even corporations should be allowed to adopt provisions dispensing with fiduciary duties, just as Delaware limited partnerships and LLCs are.

If you lack such abiding faith in market efficiency, however, you are in quite a quandary, because you then have to decide which private ordering innovations to tolerate, and which to regulate. As things stand, Delaware has made that decision, at least in relation to fiduciary duties: if you buy a limited partnership interest, the fiduciary duties you are owed may be limited or eliminated by the limited partnership agreement; if you buy corporate stock, on the other hand, fiduciary duties are mandatory and can’t be eliminated, even by charter provision (although, of course, director monetary liability for breach of the duty of care can be eliminated under Delaware General Corporation Law Section 102(b)(7)).

In regard to fiduciary duties, Delaware could choose to stand by this approach that bifurcates between corporations and other forms of entity. Alternatively, and recognizing that publicly traded noncorporate entities are still a somewhat limited phenomenon, Delaware could at least prospectively put all publicly traded entities on the same footing, by precluding publicly traded limited partnerships and LLCs from limiting or eliminating fiduciary duties. My “alternative entity” friends might gasp at that prospect, but they need to tell me why they are confident that the IPO market for limited partnership interests fairly and accurately prices provisions that limit or eliminate fiduciary duties. And they need to be confident that Vice Chancellor Noble’s concern that “another governmental entity [who ever might he be referring to?] might step in and provide more protections for the public investors” is just remote speculation, or that such regulation would be desirable or at least acceptable.  That said, one can question whether the EPE limited partnership agreement addressed by Vice Chancellor Noble really represents the “outer reaches” of the flexibility afforded under the Delaware limited partnership statute:  the operative provision addressing conflict transactions did not purport to effect a blanket elimination of all fiduciary duties; all it did was define various forms of effective approval for conflict transactions, including approval by a special committee of directors, a form of approval generally viewed as appropriate under corporate law as well.   Likewise, the provision establishing that directors act in good faith when they rely on the opinion of an expert on a matter they reasonably believe to be in the expert’s area of competence doesn’t seem radically different than the rule embodied in Section 141(e) of the Delaware General Corporation Law, protecting directors’ good faith reliance on expert opinions reasonably believed to be within the expert’s professional competence.  Perhaps the biggest difference from the corporate statute is that the partnership agreement provision appears to eliminate the predicate that the director’s reliance be in overall good faith, and not just based on a reasonable belief in the expert’s competence.  Even if the partnership agreement provisions at issue are somewhat more protective than what is available as a matter of corporate law, however, it seems likely to me that those provisions are relatively modest in their impact, at least compared to what the limited partnership statute might actually permit.

In regard to dispute resolution matters, the law is still largely unsettled. Given the Delaware legislature’s explicit embrace of freedom of contract in noncorporate entities, will mandatory arbitration provisions like Carlyle’s be deemed valid and become commonplace in such entities that are publicly held? And do such provisions offend some mandatory aspect of corporation law such that Delaware public companies will be unable to adopt them? Is litigating in the Court of Chancery a fundamental, non-excludable right for stockholders, but litigating in a court outside of Delaware is not? Or if charter forum selection provisions for Delaware public companies become common, will arbitration selection provisions become similarly common?

Is there a comprehensive way to decide what private ordering – which may amount to no more than a take it or leave it investment choice – should allow, and what is off limits?

Reaction to Jim McRitchie’s comments on precatory proxy access proposals

Last week Jim McRitchie provided a thoughtful response to my post questioning the utility of precatory proxy access proposals.  As you’ll see from his response, he draws on analogies to political democracy, and why “let the people decide” doesn’t mean “let the people decide everything:”

Generally, the “people decide” in democracies by delegating authority to their elected representatives. As voters, we get involved directly in nominating and electing candidates but generally then hope that our representatives will work in our interest. We pass along advice and concerns. If our elected officials fail to represent us, we the people again act more directly through initiatives, recall, etc.

With regard to how “pass[ing] along advice and concerns” should work, McRitchie says: 

Directors have much to add to the debate.  Let’s hear from them.  I’m not opposed to submitting binding bylaws but what’s wrong with asking first?  If our proposals are successfully endorsed by shareholders but ignored by directors then I would be ready to escalate, not only by submitting binding bylaw proposals but also by calling on shareowners to vote against directors who ignore the will of the voters.

I certainly support the idea of constructive engagement before shots are fired, and McRitchie’s commentary certainly persuades me that the precatory aspect of United States Proxy Exchange’s strategy is a reasonable approach.  The new Latham & Watkins model proxy access bylaw and commentary remind me how devilishly complex the details of a proxy access bylaw are (not to mention related matters of advance notice bylaws and qualification bylaws).  So I agree with McRitchie that the precatory approach is a useful way “avoid getting into the weeds on company specific legal issues better left to corporate attorneys.” 

There’s still a residual problem, however, where I suspect that McRitchie and I continue to disagree, namely on how a board of directors should evaluate the results of a vote on a precatory proxy access proposal.   McRitchie is evidently ready to call on shareholders to vote out directors who “ignore the will of the voters,” but how does one discern what that “will” is, when a vote is on general principles and avoids getting “into the weeds” where critical issues lie?  If “[d]irectors have much to add to the debate,” as McRitchie correctly argues, isn’t it implicit that they need to exercise judgment and not accede to what they believe are misguided precatory proposals, especially where there’s no cost to shareholders for voting for a proposal that isn’t adequately thought through? 

 

Espinoza v. HP

The Delaware Supreme Court issued its ruling yesterday in Espinoza v. Hurd, a case in which the plaintiff — an HP stockholder — invoked the Delaware corporate inspection statute (DGCL section 220) to inspect a report by Covington & Burling to the HP board evaluating claims of sexual harrassment by CEO Mark Hurd. 

The opinion by Justice Jacobs is very narrow and very careful. In evaluating the Court’s decision affirming the denial of the plaintiff stockholder’s access to the Covington report, it is important to keep in mind, as the Court’s opinion did, that documents reflecting the actual facts bearing on the issue of whether Mr. Hurd should have been dismissed for cause had already been turned over to the plaintiff. The Court also noted, as a factual matter, that the Covington report didn’t directly address the “for cause” termination issue – and that had it done so, the case might have come out differently.

The Court of Chancery had reached the same result, but in reliance on a claim of attorney-client privilege. As against stockholders, however, that privilege is qualified, and will be applied, or not, depending on factors like the strength of the stockholder’s underlying claim and whether the information in question is otherwise available. The lower court’s result may well mirror the Supreme Court’s reasoning – particularly as it relates to the availability of key information from other sources. The major difference between the Supreme Court and the Court of Chancery, however, appears to be on the question of which mode of analysis – entitlement under Section 220 (the Delaware corporate inspection statute) and under attorney-client privilege (a common law issue) – should be applied first. The Supreme Court chose the former, believing that one should decide whether the stockholder is entitled to review the document under the inspection statute, before deciding whether a claim of privilege bars that inspection. It’s a logical preference, although it’s not clear that the result would or should have been any different, and the Supreme Court disavows any pronouncement about how the privilege issue would have been resolved.

I’d like to think that after the Disney/Ovitz litigation, the HP board devoted specific attention to whether the circumstances warranted dismissing Mr. Hurd for cause. If they did, and in light of the ultimate outcome in the Disney case, it will be a tough slog for the plaintiffs in the underlying derivative suits to win a claim against the HP directors.

Precatory proxy access proposals

United States Proxy Exchange has published a model proxy access proposal under revised SEC Rule 14a-8. I am struck by the fact that it’s precatory, not mandatory: even though Delaware law (DGCL Section 112) clearly permits stockholders to adopt such a bylaw themselves, the USPE model only calls for a vote to recommend that someone else — namely, the board of directors — do the deed that the stockholders could do for themselves.

Can someone tell me why an organization whose motto (“Populus Constituit”) means “the people decide” (“people” presumably meaning stockholders) is apparently so reluctant to actually let “the people decide?”

I have a suspicion about the reason: USPE is probably savvy enough to think that a mandatory bylaw proposal won’t get nearly as high a vote as a diluted, precatory proposal. But if that’s the case, however, won’t it be reasonable for boards of directors not to take even a majority vote on a precatory proposal seriously, in the belief that if real bullets had been at stake the stockholders themselves wouldn’t have voted for it? Why the reluctance to actually find out how stockholders would vote on whether to use the powers that they clearly have under state law?

Helen S. Balick Chair in Business Bankruptcy Law

Widener Law School has initiated a search to fill a newly created faculty position: the Helen S. Balick Chair in Business Bankruptcy Law. Without further editorializing, here’s the text of the job posting:

* * *

WIDENER UNIVERSITY SCHOOL OF LAW invites applications for the newly established Helen S. Balick Chair in Business Bankruptcy Law. That Chair honors Judge Balick’s pivotal role in the national development of business bankruptcy proceedings, and is intended to stimulate and coordinate constructive debate on issues germane to business bankruptcy law. It is contemplated that the occupant of the Chair will take advantage of her or his prior experience and scholarship, together with proximity to the Delaware bench and bar, to advance the law school’s contributions to the field of business law through its Institute of Delaware Corporate and Business Law. The Helen S. Balick Chair will hold the following responsibilities:

1. Publishing scholarly articles on the subject of business bankruptcy;
2. Facilitating research relating to business bankruptcy issues;
3. Promoting the teaching and training of students, judges, and practicing lawyers in the business bankruptcy field;
4. Developing print and web-based publications on business bankruptcy topics for use by the local and national bench and bar; and
5. Organizing periodic seminars and symposia on current and important issues in business bankruptcy law and practice.

A record of scholarly achievement is required. Although our search is focused on those working in the field of business bankruptcy law, accomplished scholars in other areas involving business law are invited to apply. Women, members of minority groups, and others whose backgrounds will contribute to the diversity of the faculty are encouraged to apply. Nominations for the Chair are also welcome.

Contact: Lawrence A. Hamermesh, Chair, Balick Chair Search Committee, Widener University School of Law, 4601 Concord Pike, Wilmington, Delaware 19803, lahamermesh@widener.edu.

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Reactions to Professor Bainbridge

Ann E. Conaway, Professor of Law
Widener University School of Law

To clear the air, my “nice, short” treatment of Abolishing Piercing for LLCs in Delaware under an Alter Ego Theory is nothing akin to Professor Bainbridge’s article. As for what Professor Bainbridge seems to espouse – the total elimination of veil piercing for LLCs because of judicial subjectivity and the agency costs of such unpredictability – I say not so! The Delaware Court of Chancery and Supreme Court of Delaware have for over 250 years, in the aggregate, dealt with “subjective” and “equitable” issues that have lead to the most predictable business law in the United States. My premise is for Delaware only. My thesis is rather simple. Delaware’s unincorporated entities operate under a stated public policy of freedom of contract. Freedom of contract does not have fiduciary duties – corporate law does. The alter ego doctrine of veil piercing in corporate law in Delaware inevitably comes back to proof of fraud and illegality. The alter ego doctrine is a corporate doctrine that, like fiduciary duties, meshes with a corporate paradigm. The alter ego principle has no place in entities that operate from a basis of a policy of freedom of contract where owners may or may not have an economic interest in the entity. Therefore, it is my proposal that alter ego should be abolished for Delaware LLCs – not all veil piercing! My proposal is that alter ego should be replaced by a rigorous judicial inquiry into fraud or illegality into the use of the LLC franchise by those upon who creditors or others wish to impose personal liability. This proposal is not that of Professor Bainbridge – however “nice” and “short” my premise may be. I trust our Delaware judiciary to recognize fraud and illegality and to maintain the predictability for which the State of Delaware has become known.

Professor Conaway on Veil-Piercing in LLCs

On My Mind
Professor Ann E. Conaway
Widener University School of Law
Wilmington, DE

In recent months, I have had the opportunity to re-examine a longstanding Delaware corporate equitable principle – that of piercing the corporate veil on the basis of alter ego. My opportunity was sparked by an expert case in South Carolina that arose in the context of several Delaware LLCs organized as parent-subsidiaries in a real estate condominium conversion. In my research, I found three Delaware Chancery Court opinions that each assumed, without any explanation or supportive reasoning, that Delaware corporate alter ego principles should apply in toto to Delaware LLCs. After extensive research and thought on the matter, I respectfully disagree with the Delaware Courts and advocate instead the abolition of the veil piercing doctrine in favor of a test of fraud or illegality in the case where a Delaware LLC franchise is being sought to be pierced.

First, the Delaware corporate cases are in a somewhat confused state. The Delaware Courts appear to apply the alter ego test to corporations in two circumstances: (1) when trying to impose liability on a natural person who is the sole or dominant shareholder of a corporation; and (2) in a parent-subsidiary context. In most jurisdictions, alter ego is properly applied in the first scenario since the corporate shield is being used as an “alter ego” for the natural person’s individual, non-business activities. In the second scenario, traditional corporate dogma does not apply an alter ego test since: (1) control is always present; (2) transferring funds from the sub to the parent is legal; (3) corporate formalities are more likely to be present between separate legal entities; and (4) capitalization alone is never dispositive for piercing. Instead, as between two independent legal entities, the test is generally proof of fraud or illegality. Indeed the Delaware Courts, after paying lip service to the terms alter ego, avoid application of the factual tests of that theory and move directly to a determination of fraud, illegality or injustice in the use of the corporate franchise.

In an unusual Chancery Court opinion, VC Parsons pierced the veil of a Delaware corporation to reach a natural, individual shareholder in Midlands Interiors, Inc. v. Burleigh, 2006 Del.Ch. LEXIS 20 (Dec. 19, 2006). Without citing the equitable theory of alter ego, the Court found that there was clear evidence of fraud where an administratively dissolved corporation continued to conduct the exact same business with creditors notwithstanding its known dissolution. The case, when it first was published, caused some concern among the Delaware Bar. However, some comfort could be gained from the fact that the elements of alter ego did not sustain the Court’s holding. Rather, an egregious set of fraudulent facts led the Court to its finding – a standard higher than “alter ego.”

So, what’s on my mind? In light of the recent Delaware Supreme Court opinion in CML V v. Bax, the Supreme Court made clear that investors have a “choice” between a corporation and an unincorporated entity. That choice, according to the Supreme Court, affects the law that applies to the entity. As the Supreme Court made obvious in CML V, corporate law has no place in Delaware LLCs. Specifically, as regards to the “alter ego” test: (1) LLCs have no “corporate formalities” and to the extent an operating agreement imposes “formalities,” those formalities are meant solely for the parties to the agreement and do not affect limited liability; (2) the “dominant shareholder” factor is irrelevant in LLC law where a “dominant” member may be a non-economic member; and (3) “undercapitalization” by shareholders is also a non-relevant concept in LLC law, since members in an LLC are not required to make contributions to become members. In sum, the alter ego theory of corporate law is premised on pro rata ownership of stock and other mandatory corporate organizational and operational rules. Virtually no “mandatory” rules exist in LLC law.

Further, an “alter ego” test for piercing should never be used to ignore the internal shields of a Delaware “series” LLC. Unlike a regular LLC, a “series” LLC permits an allocation of property, obligations or assets of the LLC into “cells” or “units” if the certificate of formation gives notice of the series and its internal limitation on liability. A Delaware series may then grant any rights, duties, profits, losses or management rights to be associated with any particular series. Separate books must be kept for each series. Each series may have an independent business or investment purpose. According to the 2007 amendments to the series, a series may sue, be sued, or contract in is own name and may grant security interests or liens. A series under Delaware law is not an entity. A series is, however, a person under the statute. If a creditor gets a judgment against a series and the assets are insufficient to pay the judgment, it is suggested in some commentary that veil piercing is available. The notion is that the veil is pierced to reach the “assets” of the series. Yet, this argument is misleading. The judgment reaches the assets. A veil piercing action ostensibly seeks to pierce the internal wall of liability limitation and impose personal liability on those persons associated with the series whether they are members, managers or other persons named under the operating agreement. If veil piercing is available in this context, it makes even less sense to use “alter ego.” The only fair test must be clear evidence of fraud or illegality – with an attempt to avoid liability not constituting fraud or illegality. In any event, veil piercing in the circumstance of a series should never permit a judgment to leap from one series to another – that concept is consolidation and is best left to the bankruptcy courts.

So what is the answer to this conundrum? Because Delaware has consistently required proof of fraud and illegality in addition to the “true” alter ego cases, it only makes sense to eliminate the corporate paradigm from LLC law and instead to replace it with the consistent Delaware standard of factual proof of fraud or illegality in the use of the LLC franchise (or series thereof) to perpetuate social injustice.

Professor Regan on the Goldman Sachs Decision

— Prof. Paul L. Regan, Widener University School of Law, Wilmington, Delaware

Newly installed Vice Chancellor Sam Glasscock has issued an opinion dismissing a shareholder derivative action that the shareholders of Goldman Sachs attempted to bring on behalf of the company against its directors and officers arising from the company’s compensation plan during the recent mortgage crisis and its aftermath. In In re The Goldman Sachs Group, Inc. Shareholder Litig., C.A. No. 5215-VCG (Del. Ch. Oct. 12, 2011), the shareholders of Goldman Sachs alleged that the company’s directors breached their fiduciary duties by establishing a compensation structure that assertedly encouraged highly “risky trading practices and over-leveraging of the company’s assets.” The plaintiffs also alleged a Caremark claim, asserting the Goldman directors failed to fulfill their oversight responsibilities with regard to the firm’s compensation plan which in turn, according to the plaintiffs, led to unethical and illegal business practices as well as overly-risky business decisions.

The defendants successfully moved to dismiss the complaint under Court of Chancery Rule 23.1 for failure of the plaintiffs to allege with particularity that pre-suit demand was excused. With regard to the decision of the Goldman board to approve the firm’s compensation structure, Vice Chancellor Glasscock applied a straightforward Aronson analysis and concluded that the complaint failed to allege (1) that the board was interested or lacked independence when it approved the compensation scheme or (2) that the board did not otherwise validly exercise its business judgment in this regard. On the Caremark claim, the Court applied the Rales test and ruled that the complaint failed to allege with particularity that the Goldman directors faced a substantial likelihood of personal liability on their asserted failure to fulfill their oversight responsibilities. Thus demand was not excused because the plaintiffs did not allege facts creating a reasonable doubt that the Goldman directors would be deemed personally interested in responding to a demand that such an oversight claim be brought.

As noted the Court’s application of the Aronson test was fairly straightforward. Of note here is the Court’s Caremark analysis. The plaintiffs asserted that the Goldman directors failed to fulfill their fiduciary duty of oversight both with regard to monitoring compliance with applicable law and the company’s business performance and risk. The Court’s rejection of the complaint’s legal compliance/oversight claim conventionally followed Caremark and Stone v. Ritter. On the issue of monitoring business risk (as opposed to legal compliance), Vice Chancellor Glasscock noted that “this Court has not definitively stated whether a board’s Caremark duties include a duty to monitor business risk.” Goldman Sachs, slip op. at 60. Ultimately however, the Court declined to reach this interesting legal issue, ruling that the complaint failed to allege that the Goldman directors “acted in bad faith or consciously disregarded their oversight responsibilities in regards to Goldman’s business risk.” Id. at 64. As in the Citigroup case decided in 2009 by then Chancellor William Chandler, Vice Chancellor Glasscock signaled very little patience for the plaintiffs’ attempt to recast a claim attacking a business judgment over employee compensation into a oversight claim concerning business risk. Emphasizing the traditional judicial inquiry into the process but not the substance of board decision-making, the Court in Goldman Sachs emphasized: “If an actionable duty to monitor business risk exists, it cannot encompass any substantive evaluation by a court of a board’s determination of the appropriate amount of risk.” Id. at 62.

Following the Court of Chancery’s decisions in Goldman Sachs and of course Citigroup, it remains unsettled whether Caremark’s early reference to the possibility of an oversight claim arising from a board’s monitoring of business risk is viable. Outside of Delaware, the Model Business Corporation Act suggests such a possibility, at least with regard to “major risks” facing a publicly owned company. See MODEL BUSINESS CORPORATION ACT, Section 8.01(c)(2) (“In the case of a public corporation, the board’s oversight responsibilities include attention to … major risks to which the corporation is or may be exposed”.) The early returns from Delaware case law suggest a different emphasis in policy on the question of director accountability for business risk — i.e., protecting the board’s managerial authority under our director-centric model of corporate governance; encouraging entrepreneurial risk taking; encouraging qualified directors to serve; avoiding the unfairness of hindsight bias for decisions that turn out badly; and avoiding second guessing of business decisions by ill-equipped members of the judiciary. Thus far at least, the Delaware Court of Chancery has concluded that a conventional business judgment rule analysis should apply to such “oversight” business risk claims. Diversified stockholders who are unhappy with what they regard as unreasonable levels of business risk can always exit by selling their shares or otherwise seek to replace the directors in a contested election.

More on De-Annualizing the Stockholder Meeting: An Apology and Belated Recognition to Professor Sjostrom

In the recent back and forth on the question of the continued utility of the annual meeting, I’ve been remiss in failing to refer to Professor William Sjostrom Jr.’s article on the subject, “The Case Against Mandatory Annual Director Elections and Shareholders’ Meetings,” which is available here

In reminding me of this article, Professor Sjostrom appropriately laments that it didn’t get a great deal of attention when it was published. This supplemental post is an attempt to remedy that, belatedly, and to suggest that perhaps Professor Sjostrom was just ahead of the rest of us. In any case, I’m glad to join him in focusing on whether the stockholder voting process could be improved.

The “money” lines from Professor Sjostrom’s article, as far as I was concerned, are these:

“There simply is no strong justification for requiring director elections and shareholder meetings annually. Annual elections provide at most a minimal check on management, a check that is not dependent on the frequency of elections. Nor are annual elections critical to the exercise of corporate democracy. Likewise, annual shareholders’ meetings provide little if any opportunity for shareholder deliberation … .”

Evidence Regarding Majority Voting — A Reply to Jim McRitchie

It’s always a treat for a professor to be discussed by a widely read authority, and an especially rare treat to be credited by such a person with saying something clever. So I was pleased to see that Jim McRitchie commented on a couple of my recent postings.

As to the asserttion that I was being “clever,” I respectfully disagree: all I did was present evidence that changing the Delaware default rule for the voting standard in director elections wouldn’t have much formal effect, in light of how frequently Delaware corporations appear to adopt controlling bylaw provisions that make the default standard moot. McRitchie doesn’t challenge this evidence, and I stand on my criticism of the factual assertion that many Delaware corporations adopt the plurality vote standard by default.

More usefully, McRitchie makes the potentially plausible point that a change to the Delaware standard might have an informal impact by encouraging companies to amend plurality vote bylaws and replace that standard with a majority vote standard. That may or may not be so – seems fairly speculative to me – but I didn’t intend to take a position on whether changing the default voting standard would be a good or bad thing. In any event, McRitchie says I’m guilty of “status quo thinking,” which I take to be intended as a pejorative comment. As to that, I have two responses:

First, my post on reframing shareholder voting and potentially eliminating a knee-jerk adherence to having annual shareholder meetings is anything but “status quo thinking;” one could accuse McRitchie of status quo thinking in dismissing my suggestions as wrong ideas, rather than exploring whether reducing the frequency of meetings and voting might be worth it to shareholders if they were given greater power and influence in connection with less frequent meetings.

Second, “status quo thinking” may to some extent simply be a recognition of the reality that some ideas just aren’t in the cards, in any foreseeable future. Example: McRitchie agrees that annual meetings are mostly meaningless, but he partly blames shareholder apathy on the fact that a lot of voting is on merely precatory resolutions. But addressing the meaninglessness of annual meetings by making precatory resolutions mandatory just isn’t going to happen, and shouldn’t. We have a director-centric model of corporate governance, I see no serious support for turning every 14a-8 shareholder proposal into a binding referendum. I suggest that my approach is much closer to the realm of possibility, as long as management and shareholder representatives are willing to recognize that the system could be improved if they both could at least discuss and then maybe agree on acceptable trade-offs that make the shareholder voting system more effective. Those potential trade-offs, by the way, include some sort of enhancement of proxy access.

So, I renew my invitation to McRitchie and other leading corporate governance authorities to explore reforms that offer both management and shareholders (but not necessarily their intermediaries) a better deal. And I reiterate that I’m not suggesting eliminating annual meetings as an isolated, unilateral measure: reducing the extent of shareholder voting depends on management’s willingness to make less frequent voting more meaningful, particularly in relation to the election of directors.