All posts by Lawrence Hamermesh

Fee-Shifting Bylaws: A Study in Federalism

Lawrence A. Hamermesh and Norman M. Monhait(fn1)

An exchange last month in the Bank & Corporate Governance Law Reporter among Neil Cohen, Jack Coffee and Jay Brown(fn2) addressed the possibility that corporate bylaws might regulate the award of attorney’s fees in federal securities class actions. The Delaware Supreme Court’s 2014 opinion in ATP(fn3) sparked renewed interest in this possibility, and when the Delaware State Bar Association’s Corporation Law Section proposed legislation limiting the use of charter and bylaw provisions to shift litigation expenses, it was noted (correctly) that the proposed legislation did not apply to federal securities claims.(fn4) From this premise, it has been suggested (incorrectly, we say) that bylaws providing for fee-shifting in federal securities class actions were implicitly endorsed, or at least remained viable as a matter of Delaware law.(fn5)

We are responding to the foregoing suggestion to make two points: first, the now enacted Delaware legislation (“SB 75,” which includes amendments to Sections 102 and 109 and the Delaware General Corporation Law (DGCL), and the addition of Section 115 to that statute(fn6)) does not affect the question of the validity of bylaws providing for fee-shifting in federal securities class actions; and second, in our view the DGCL did not and after passage of SB 75 does not authorize such bylaws.

We begin with a point on which Professors Coffee and Brown appear to agree: namely, that SB 75 does not apply to federal securities class action litigation. By its terms, the legislation only applies to bylaws that provide for fee-shifting in connection with “internal corporate claims.” New Section 115 defines that term as “claims, including claims in the right of the corporation, (i) that are based upon a violation of a duty by a current or former director or officer or stockholder in such capacity, or (ii) as to which this title confers jurisdiction upon the Court of Chancery.” If federal securities claims are covered by this term, they must fall within at least one of the two definitional clauses. It’s easy to see that clause (ii) does not cover federal securities claims, because the DGCL does not “confer[] jurisdiction upon the Court of Chancery” to hear such claims.

Nor do federal securities claims typically fall within clause (i) of the definition of “internal corporate claims.” The predominant form of federal securities class action litigation is based on Section 10(b) of the Securities Exchange Act of 1934(fn7) and SEC Rule 10b-5(fn8), and most commonly involves allegations that a material misstatement or omission induced class members to purchase securities before the misstatement or omission was corrected. In that situation, the fraud is visited upon investors, but not stockholders as such: it should be irrelevant whether a class member was or was not already a stockholder at the time of the alleged fraud. As Vice Chancellor Laster recently concluded in the Activision litigation: “A Rule 10b-5 claim under the federal securities laws is a personal claim akin to a tort claim for fraud. The right to bring a Rule 10b-5 claim is not a property right associated with shares, nor can it be invoked by those who simply hold shares of stock.”(fn9)

Accordingly, any duty breached under Rule 10b-5 (or under Sections 11 or 12 of the Securities Act of 1933(fn10)) does not arise from a director or officer’s duty to the corporation or its stockholders, and a Rule 10b-5 claim should not be considered an “internal corporate claim” within the meaning of new Section 115. Of course, if a director’s or officer’s violation of Rule 10b-5 were understood to involve a violation of his or her duty as a director or officer, then the amendments to DGCL Sections 102 and 109 would prohibit a bylaw providing for fee-shifting in connection with litigation of Rule 10b-5 claims. But like Professors Brown and Coffee, we think that a better reading of these amendments would regard them as limited to the Delaware “lane,” namely to breaches of duty arising under the DGCL and Delaware corporate decisional law. Therefore, we believe that the recent amendments to the DGCL do not address the validity of a bylaw purporting to shift fees in federal securities class action litigation.

So where does that leave such bylaws in terms of validity under Delaware law? In our view, their validity remains exactly as it was before the legislation was enacted. There is nothing to suggest any intention to endorse or accomplish, by negative implication, a validation of bylaws (or charter provisions, for that matter) purporting to regulate litigation arising under any body of law (tort, contract, federal securities law) other than Delaware corporation law.

Instead, the efficacy of a fee-shifting charter or bylaw provision purporting to affect federal securities class actions must be determined under Delaware case law interpreting the scope of DGCL Sections 102(b)(1) and 109(b) – most notably, the opinions in ATP and FedEx/Chevron (fn11)(by then Chancellor Strine). And as we read those opinions, Sections 102(b)(1) and 109(b) cannot be read, despite their breadth and the presumptive validity of provisions adopted pursuant to them, to authorize provisions regulating litigation under the federal securities laws.

Both ATP and FedEx/Chevron are instructive in this regard. Starting with the latter (but earlier) opinion, we see that what the court was endorsing was a bylaw that it considered to affect forum selection for “the kind of claims most central to the relationship between those who manage the corporation and the corporation’s stockholders” – namely, “suits brought by stockholders as stockholders in cases governed by the internal affairs doctrine.”(fn12) In contrast, the court went out of its way to distinguish a bylaw regulating “external” matters, such as “a bylaw that purported to bind a plaintiff, even a stockholder plaintiff, who sought to bring a tort claim against the company based on a personal injury she suffered that occurred on the company’s premises or a contract claim based on a commercial contract with the corporation.”(fn13) A bylaw regulating selection of a forum to litigate such external claims “would be beyond the statutory language of 8 Del. C. 109(b)” for the “obvious” reason that it “would not deal with the rights and powers of the plaintiff-stockholder as a stockholder.” (emphasis in original). As previously noted, a bylaw purporting to regulate the litigation of claims under Rule 10b-5 “would not deal with the rights and powers of the plaintiff[] as a stockholder,”(fn14) and would therefore not be within even the broad scope of Section 109(b).

Nothing in ATP altered this analysis. Addressing the principal certified question in that case, the Court was necessarily focused on “suits brought by stockholders as stockholders in cases governed by the internal affairs doctrine.”(fn15) (emphasis added). In the underlying litigation, the plaintiffs alleged “Delaware fiduciary duty claims,” as well as antitrust claims.(fn16) There is no indication in the ATP opinion that the Supreme Court questioned former Chancellor Strine’s view that the “flexible contract” formed by the statute, charter, and bylaws could not extend to any litigation other than “suits brought by stockholders as stockholders in cases governed by the internal affairs doctrine.” Indeed, if the underlying litigation had involved only antitrust claims, we have no doubt that the Court would have concluded (consistent with FedEx/Chevron) that the bylaw could not have provided for fee-shifting in relation to the claims presented. And having been asked merely to opine about the overall facial validity of the bylaw, the Court had no occasion to parse the facts to determine whether the bylaw could require shifting fees that might have been solely attributable to the antitrust claims.

In sum, the “flexible contract” identified in ATP and established by the DGCL, the certificate of incorporation, and the bylaws encompasses a great deal – the subject matter scope of Sections 102(b)(1) and 109(b) is broad. But it is not limitless, as FedEx/Chevron expressly teaches. And in our view, it does not extend so far as to permit the charter or the bylaws to create a power to bind stockholders in regard to fee-shifting in, or the venue for, federal securities class actions. In addition, we agreed with Professor Coffee’s forceful point that a state authorization of charter and bylaw provisions purporting to control fee-shifting and venue in federal securities class actions is likely to be held pre-empted, regardless of their validity or effect under state law.(fn17) Given our views of Delaware law, we saw no reason for a statutory amendment that purported to reach beyond the confines of internal governance litigation, and we supported drafting that, as Professor Brown rightly suggests, stayed within Delaware’s “lane.”

(1) Mr. Monhait is the immediate past chair, and Professor Hamermesh a prior chair and a member, of the Council of the Delaware State Bar Association’s Corporation Law Section. The views expressed here, however, are solely those of the authors, and do not necessarily represent the views of the Association, the Section, or its Council.
(2) J. Robert Brown, Jr., Staying in the Delaware Corporate Governance Lane: Fee Shifting Bylaws and a Legislative Reaffirmation of the Rules of the Road; John C. Coffee, Jr., What Happens Next?; Neil J. Cohen, What Is the Outlook for Fee-Shifting in Securities Fraud Litigation After Delaware Passes a Ban on These Provisions for “Internal Corporate Claims”?.
(3) 91 A.3d 554 (Del. 2014).
(4) John C. Coffee, Jr., Delaware Throws a Curveball, Mar. 16, 2015, available at (“read literally, the new legislation would not preclude a board-adopted bylaw that shifted the corporation’s and other defendants’ expenses against a plaintiff who lost (or was less than substantially successful) in a federal securities class action (at least so long as the action did not allege a “violation of a duty” by any corporate officer or director).”).
(5) Id. (“the proposed legislation may protect “Delaware-style” litigation from the threat of fee-shifting, but not securities class actions.”).
(6) SB 75, available at$file/legis.html?open.
(7) 15 U.S.C. §78j(b).
(8) 17 C.F.R. §240,10b-5
(9) In re Activision Blizzard Inc. Stockholder Litigation, C.A. No. 8885-VCL (Del. Ch. May 21, 2015), slip op. at 50.
(10) 15 U.S.C. §§ 77k, 77l.
Boilermakers Local 154 Retirement Fund v. Chevron Corp., 73 A.3d 934 (Del. Ch. 2013).
(11) 73 A.3d at 952.
(12) Id.
(13) Id. In cases involving such external claims, the stockholders indirectly bear the costs of the litigation to the corporation, but FedEx/Chevron makes clear that this circumstance does not convert the matter into one within the internal affairs of the corporation and subject it to regulation by the charter or bylaws of the corporation.
(14) Id.
(15) 91 A.3d at 556.
(16) John C. Coffee, Jr., Federal Pre-Emption and Fee-Shifting, (Jan. 26, 2015), available at

Not Your Average Fee-Shifting Provision

Jennifer Buckley (Widener Delaware ’16) concludes her article on the fee-shifting controversy as follows:

The current effort to legislate away fee-shifting bylaws is to be applauded for attempting to combine strong protection of shareholder interests with an acknowledgement of corporate concerns in the legitimization of forum selection bylaws. If it passes, then those concerned about excessive litigation will no doubt develop another tool for deterring frivolous shareholder lawsuits. If it does not pass, then one way to generate broad support could be to adopt one or more of the moderate approaches described here. These proposals seek to balance the legitimate interests of plaintiff shareholders with those of the corporations in which they invest. Moving forward, any legislation that seeks to protect shareholders must keep in mind the business community’s concern over excessive litigation. Likewise, proponents of fee-shifting bylaws must be willing to agree to reasonable limitations that soften their negative impact on plaintiff shareholders, especially those without a ready market for their shares. As with most policy debates, the answer likely lies somewhere in the middle ground.

Ms. Buckley’s article can be reviewed at:


Ex Post Facto Fee-Shifting Law?

In a recent blog post about legislative proposals relating to charter and bylaw fee-shifting provisions, Francis Pileggi writes:

Unlike routine amendments to the DGCL, this proposed legislation confronts powerful lobbyists on both sides of the issue. Thus, this proposal may be more akin to typical legislation in which the final version of the bill that is passed is not always similar to the first version of the bill that was introduced. The only certainty about this proposed bill, is that it will generate an enormous amount of commentary and discussion. I would not expect a final outcome until the last day of the session on June 30.

If some legislation is passed that ultimately limits the ability of a corporation to adopt fee-shifting bylaws, an interesting issue will be the impact, if any, that the legislation will have on those companies that already adopted fee-shifting provisions. Generally, there is a prohibition against ex post facto laws. Stay tuned.

Francis is right that statutes generally are not interpreted to apply retroactively. But in this case, there are two circumstances that suggest that charter or bylaw fee-shifting provisions that have been adopted by Delaware stock corporations would not survive enactment of the proposed legislation.

The first circumstance is Section 394 of the Delaware General Corporation Law , which provides that “all amendments [of the DGCL] shall be a part of the charter or certificate of incorporation of every corporation except so far as the same are inapplicable and inappropriate to the objects of the corporation.” As interpreted by the Delaware courts, this statute establishes that amendments to the DGCL apply to existing corporations. There may be a legitimate argument about whether a fee-shifting provision currently in place would be enforced in litigation initiated before the proposed statutory prohibition becomes effective (if it does), but given Section 394 there’s nothing ex post facto about prohibiting the operation and application of a fee-shifting provision with respect to litigation initiated after that effective date.

Nor is there anything unfair about the operation of Section 394 in the situation at hand. Last June, the Delaware General Assembly made it clear in Senate Joint Resolution 12 that “a proliferation of broad fee-shifting bylaws for stock corporations will upset the careful balance that the State has strived to maintain between the interests of directors, officers, and controlling stockholders, and the interests of other stockholders.” In the same resolution, the General Assembly called upon the Delaware State Bar Association to consider formulating legislative proposals on this and other litigation-related subjects. Many law firm publications on the subject warned corporations to proceed with caution given the possibility of legislation. No one can fairly claim surprise that a proposal has now emerged that would prohibit fee-shifting in stock corporations by charter or bylaw provision.

In short, Delaware stock corporations that adopted fee-shifting provisions after the ATP decision came down last spring would be well advised to consider removing them if and when it appears that the proposed legislation will be enacted.

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.”

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.

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.

Kallick v. SandRidge: Proxy Put Preliminarily Panned

Chancellor Strine’s March 8, 2013 opinion in Kallick v. SandRidge Energy is a welcome reaffirmation and clarification of director duties in relation to takeover deterrents built into otherwise customary commercial transactions—in this case, a put right (the “Proxy Put”) in the company’s credit agreements that would require the company to refinance debt in the event of a change in the majority of the board not approved by a majority of the pre-existing directors.

Responding to a dissident hedge fund’s consent solicitation to replace the board, the company (SandRidge) made the (in hindsight) grievous error of warning its stockholders that replacing the board could result in “mandatory refinancing of [a] magnitude [that] would present an extreme, risky and unnecessary financial burden” on the company. Talk about playing right into the dissident’s hands! You don’t have to be as smart as Chancellor Strine to figure out that this great a burden on the electoral franchise requires some explanation. Who agreed to it? Why? And why can’t the burden be avoided? The company later tried to ride a different horse, claiming that the Proxy Put was no problem after all, because refinancing would be easy and inexpensive – a better argument in light of Unocal, of course, but regrettably awkward in light of the company’s prior position .

Those first two questions—how and why did the Proxy Put get there in the first place?—didn’t get much of an answer in the record. The Chancellor usefully reminded transactional lawyers, however, that playing with matches like the Proxy Put requires some care: “the independent directors of the board should police aspects of agreements like this, to ensure that the company itself is not offering up these terms lightly precisely because of their entrenching utility, or accepting their proposal when there is no real need to do so.” SandRidge’s lawyers involved in negotiating the credit agreements may have missed that message from the Court’s 2009 opinion in San Antonio Fire & Police Pension Fund v. Amylin Pharms., Inc., 983 A.2d 304, 315 (Del. Ch. 2009) (“The court would want, at a minimum, to see evidence that the board believed in good faith that, in accepting [a Proxy Put], it was obtaining in return extraordinarily valuable economic benefits for the corporation that would not otherwise be available to it.”).

In any event, what was done was done. The real question in the case was not how the Proxy Put got there, but what to do about it. The premise from which the Chancellor approached the question was that the board could “approve” the dissident candidates for purposes of the Proxy Put (and thereby avoid triggering it) without endorsing their candidacy. The question then became whether there was any reason not to grant such limited approval, and that’s where the defendants’ proof fell totally to the ground. The Court noted that there was nothing in the record to “indicate[] that any incumbent board member or incumbent board advisor has any reasonable basis to dispute the basic qualifications of the [dissident] slate.” And the board’s financial advisor conceded that approving the dissident slate for purposes of the proxy put wouldn’t breach any obligation to the creditors.

And most notably, the Court found that:

[T]he incumbent board and its financial advisors have failed to provide any reliable market evidence that lenders place a tangible value on a Proxy Put trigger—not a change in board composition accompanying a merger or acquisition or another type of event having consequences for the company’s capital structure, but a mere change in the board majority.

It was this failure of proof that was defendants’ undoing, given the application of a legal standard of enhanced scrutiny that requires the defendants to demonstrate at least some justification for insisting on maintaining whatever deterrent effect the Proxy Put imposed on the stockholder vote. Summarizing the governing legal rules, the Chancellor explained:

By definition, a contract that imposes a penalty on the corporation, and therefore on potential acquirers, or in this case, simply stockholders seeking to elect a new board, has clear defensive value. Such contracts are dangerous because, as will be seen here, doubt can arise whether the change of control provision was in fact sought by the third party creditors or willingly inserted by the incumbent management as a latent takeover and proxy contest defense. Unocal is the proper standard of review to examine a board’s decision to agree to a contract with such provisions and to review a board’s exercise of discretion as to the change of control provisions under such a contract.

The Court’s approach to relief bought into a nuanced alternative thoughtfully put forward by plaintiff, who had originally asked for an order requiring the board to approve the dissidents’ candidacies for purposes of the Proxy Put. Recognizing that such affirmative, mandatory relief is an uncomfortable, extraordinary thing for a court to award, the plaintiff alternatively (but no less effectively) sought an order preventing the company from soliciting revocations of stockholder consents so long as the board was declining to approve the dissidents’ candidacies. And that’s exactly what the Court granted.