Category Archives: News

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:

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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.

Widener Law’s Professor Hamermesh Gives Keynote Address at the 9th Annual Directors’ Institute on Corporate Governance

Widener University School of Law Professor Lawrence A. Hamermesh recently gave the keynote address at the ninth-annual Directors’ Institute on Corporate Governance in New York City. The Sept. 7 event was presented by the Practising Law Institute.

Hamermesh, Widener’s Ruby R. Vale professor of corporate and business law, directs the school’s Institute of Delaware Corporate and Business Law. His remarks focused on reevaluating the utility of having stockholder meetings every year, and whether less-frequent voting might enhance the quality and impact of stockholder input into corporate governance.

Hamermesh’s appearance was part of a daylong seminar where corporate directors, government officials, corporate attorneys and academics shared perspectives on the regulatory environment surrounding directors in corporate America.

The Practising Law Institute offers programs and publications that serve attorneys and legal professionals in a variety of practice areas.

Hamermesh recently returned to Widener’s Delaware campus after an 18-month leave of absence, where he served as senior special counsel with the Office of Chief Counsel of the Division of Corporation Finance at the Securities and Exchange Commission in Washington, D.C.

Professor Lawrence A. Hamermesh

Professor Lawrence A. Hamermesh

Evidence Relating to the Effect of Prescribing Majority Voting in the Election of Directors as the Default Voting Standard

Prof. Lawrence A. Hamermesh
Ruby R. Vale Professor of Corporate and Business Law
Widener University School of Law, Wilmington, Delaware

[Professor Hamermesh is a member of the Delaware State Bar Association’s Council of the Corporation Law Section (the “Delaware Council”). Nevertheless, nothing stated here represents the views of that group.]

On August 11, 2011, the Council of Institutional Investors (“CII”) requested that the Delaware Council promote the revision of the Delaware General Corporation Law (“DGCL”) to alter the default rule governing the required vote in the election of directors. Specifically, CII asks that the default rule – currently that a plurality vote is sufficient to elect directors – be amended to require some form of majority vote, at least in the absence of a contested election. (CII’s letter was published on its web site more or less concurrently with its submission to the Delaware Council, and is available here).

In its letter, CII asserts that “many corporations incorporated in Delaware adopt the plurality voting standard by default.” This is an empirically testable assertion: to “adopt the plurality voting standard by default,” a company’s bylaws would have to be silent on the question of the required vote to elect directors. If the bylaws prescribed a voting standard (either the plurality standard or some form of majority vote standard), the default rule under Section 216 of the DGCL would be displaced and would not control. The bylaws, and not the statutory default provision, would prescribe the voting standard.

It therefore seemed appropriate to evaluate whether and to what extent Delaware public company bylaws actually do or do not prescribe a voting standard for electing directors. Because of CII’s focus on smaller public companies that have not adopted majority voting bylaws, I (with the assistance of George Codding, Widener Law ‘2012) examined a sample of 150 Delaware companies in the Russell 2000 small cap index. 142 of the 150 companies in that sample (95%) have bylaws prescribing a voting standard.

This result comes with one caveat. 21 of the 150 sampled companies (14%) have a bylaw provision to the effect that a majority in interest of the combined voting power of the issued and outstanding shares of stock entitled to vote represented at the meeting shall decide any question or matter brought before such meeting. Because of their typical comprehensiveness (governing votes on “all matters” or “all actions” subject to stockholder vote), I would be inclined to interpret such a provision as defining a general voting standard applicable in all voting situations, including the election of directors, absent some specific provision requiring a different standard for the election of directors. There are arguments to the contrary, however, which, if successful, would leave the statutory default standard to govern director elections, and would result in an amendment to that standard having a somewhat greater formal impact.

On balance, the information generated from our review indicates that, contrary to CII’s assertion, very few Delaware public companies – and certainly not “many” – “adopt the plurality voting standard by default.” Thus, in the large majority of Delaware companies, a change in the default rule governing the required vote to elect directors would have no formal effect at all. Barring a statutory amendment mandating some form of majority vote standard (rather than merely prescribing that standard as a default), any change in the voting standard in most of the sampled companies would have to arise through amendments to the governing bylaw provisions. Such amendments can be accomplished by unilateral stockholder vote under the DGCL, and adoption of a bylaw prescribing a majority vote standard precludes subsequent amendment by the directors (DGCL Section 216).