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

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

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

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

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

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

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

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

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

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

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

When assessing the factors that make Delaware the favored state for incorporation, the judiciary often overshadows the legislature. Delaware’s legislature is, however, widely recognized for creating necessary flexibility and stability in corporate law. In a blog essay written for the Delaware Journal of Corporate Law, DJCL Editor-in-Chief Jacob Fedechko argues that the recent amendments to DGCL Sections 204 and 205 show how the legislature helps to create such stability.

Read more at http://www.djcl.org/blog.

In a blog essay written for the Delaware Journal of Corporate Law, Thibaut Lesure, a French LLM student in corporate law and finance at the Delaware Law School, discusses Vice Chancellor Laster’s recent opinion in El Paso Pipeline.

Read more at http://www.djcl.org/blog.

In a blog essay written for the Delaware Journal of Corporate Law, former DJCL staff member Brian King analyzes President Obama’s recent proposal for tax increases on financial institutions, and compares it to Rep. Dave Camp’s proposed tax, and the president’s 2010 proposed tax increase aimed at these firms. Mr. King explores the proposals in detail, and explains why each is as misguided and unlikely to succeed as the others.

Read more at http://www.djcl.org/blog.

In a blog essay written for the Delaware Journal of Corporate Law, Kyle Wu discusses the proposed amendments to the DGCL regarding the forum selection clauses contained within certificates of incorporation and bylaws. He argues the changes will ultimately reinforce what is already the status quo since many foreign jurisdictions already respect and enforce the ruling in Boilermakers.

Read more at http://www.djcl.org/blog.

In a blog essay written for the Delaware Journal of Corporate Law, Adam Young discusses the Tax Injunction Act’s applicability to notice and reporting requirements for out-of-state retailers. He argues that that the Supreme Court decision announced in Direct Mktg. Ass’n v. Brohl serves as a notice to out-of-state retailers that their days of tax advantages over in-state retailers may be coming to an end.

Read more at http://www.djcl.org/blog.

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 http://clsbluesky.law.columbia.edu/2015/03/16/delaware-throws-a-curveball/ (“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 http://legis.delaware.gov/LIS/lis148.nsf/vwLegislation/SB+75/$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 http://clsbluesky.law.columbia.edu/2015/01/26/federal-preemption-and-fee-shifting/.