Source: https://corpgov.law.harvard.edu/2016/07/20/the-delaware-courts-increasingly-laissez-faire-approach-to-directorial-oversight/
Timestamp: 2019-04-18 14:47:39+00:00

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Miles D. Schreiner is an attorney at Monteverde & Associates PC. This post is largely based on a recent memo by Mr. Schreiner. This post is part of the Delaware law series; links to other posts in the series are available here.
In a wave of recent cases, judges in Delaware, the state that has pioneered the nation’s corporate laws but holds less than one-third of one percent of the U.S. population, have issued opinions that dramatically curtail the rights of millions of shareholders across the country. For decades, legal scholars have opined that Delaware’s corporate-friendly laws attract droves of corporations with no actual ties to the state to incorporate there, to the detriment of investors. Several recent opinions regarding the effect of so-called shareholder “ratification” further solidify their argument that shareholders’ rights have hit rock-bottom under the stewardship of the Delaware courts, and that the time has come for legislative intervention, including federal regulation of directors’ fiduciary obligations.
Under the standard articulated in Volcano, Singh, and Corwin v. KKR Fin. Holdings LLC, 125 A.3d 304, 309 (Del. 2015), the key inquiry in shareholder litigation challenging corporate transactions submitted to a shareholder vote is whether shareholders were “fully informed” when voting. Such a significant factual inquiry at the motion to dismiss stage presents a significant problem for shareholders—how do they know if they are “fully informed” about key details, including the negotiations surrounding the transaction, director’s and management’s personal interests in the transaction, and the financial advisor’s valuation analyses and interests, when all of the relevant information sits exclusively in the possession of the likely defendants? The answer is, they don’t. Indeed, shareholders can only know as much about the transaction as their potential adversaries choose to disclose to them in the necessary Securities and Exchange Commission filings.  This is particularly true in light of a string of Delaware Court of Chancery rulings that have significantly raised the standard for obtaining expedited discovery, and denied expedition without even considering the materiality of disclosure issues because of the largely illusory availability of post-close damages for disclosure claims. Not surprisingly, in a world where “[c]onflicts between the board and financial experts who issue fairness opinions have become the norm instead of the exception,” juicy pieces of material information often emerge if and only when plaintiffs are able to obtain discovery—a task that was not always so difficult under what is commonly referred to as Delaware’s “plaintiff-friendly” motion to dismiss standard and the previously low-threshold for obtaining expedited discovery. Those “plaintiff-friendly” days appear to be long gone.
The facts that emerged after the shareholder vote in Occam illustrate why the “irrebuttable business judgment rule” standard is inherently unjust and threatens to shield troubling acts of corporate malfeasance. During fact discovery in the Occam case, plaintiffs learned that their initial disclosure claims and preliminary “expedited discovery” investigation only scratched the surface of defendants’ misconduct. Specifically, during more robust fact discovery, plaintiffs amassed extensive evidence indicating that the background section of the proxy “more closely resembled a sales document than a fair and balanced factual description of the events leading up to the Merger Agreement.” The Court noted that “the evidence suggesting a slanted and misleading approach to the background section [was] particularly troubling because the defendants [had] asked the court to take judicial notice of the contents of the Proxy Statement and rely on its factual accuracy both for purposes of a motion to dismiss and in connection with the preliminary injunction hearing.” In other words, had the Occam court held earlier in the litigation that the business judgment rule irrebutably applied because the corrective disclosures rendered shareholders “fully informed”, shareholders likely would never have known that the corrective disclosures and limited information garnered during expedited discovery actually only addressed a few of several serious disclosure violations. Indeed, in addition to the misleading disclosures about the sale process, plaintiffs also unearthed disclosure issues concerning the reliability of the company’s projections and the description of the information that the company’s financial advisor relied upon for its fairness opinion.
In sum, “Delaware, has taken a largely laissez faire attitude to directorial oversight…”, and recent decisions from the state’s courts threaten to further erode shareholders’ already limited rights. As a respected law professor wrote in advocating for the federal regulation of corporate law, “[t]he only way out of this mess is to have corporate law be federal law, and for Congress or the SEC to define the obligations of corporate managers and directors.” Until then, absent a shift in Delaware law, for an overwhelming majority of aggrieved shareholders, the only available recourse will be attempting to (somehow) prevail under the increasingly inequitable laws of an increasingly challenging forum.
 While shareholders could theoretically investigate potential disclosure issues via an appraisal action or a Section 220 books and records action, various issues make such tactics largely impractical. First, because of economic realities, appraisal actions cannot realistically be pursued by small shareholders. Indeed, the Delaware legislature recently passed a bill that will limit appraisal rights to holders of $1 million or more of a company’s stock or 1 percent of the outstanding shares, whichever is less. Steven Davidoff Solomon, Delaware Effort to Protect Shareholders May End Up Hurting Them, N.Y. Times, May 24, 2016, (“[T]he $1 million minimum seemingly unfairly knocks out small shareholders but not professional hedge funds. There should be a remedy for a small shareholder who feels ill-treated.”). With respect to Section 220 actions, shareholders still need to establish a “credible basis to infer wrongdoing through documents, logic, testimony or otherwise,” a burden that may not be met even in circumstances that would appear relatively egregious to the average shareholder. See City of Westland Police & Fire Ret. Sys. v. Axcelis Techs., Inc., 1 A.3d 281, 287 (Del. 2010) (affirming order dismissing § 220 action premised upon board’s action to override shareholder’s decision to withhold voting for certain directors by rejecting directors’ resignations). Thus, shareholders are faced with the same problem – how do they establish a “credible basis to infer wrongdoing” when all of the necessary evidence is in the possession of their potential adversaries? Further, even if a shareholder is successful in bringing a § 220 action, the limited scope of the documents defendants are required to make available prevents shareholders from inspecting “all the documents that he or she believes are relevant or even likely to lead to information relevant to that purpose.” Norfolk County Ret. Sys. v. Jos. A. Bank Clothiers, Inc., No. 3443-VCP, 2009 Del. Ch. LEXIS 20, at *18 (Del. Ch. Feb. 12, 2009). Thus, corporate directors are largely able to limit the scope of information they share with shareholders who pursue § 220 actions, and can refuse to produce documents that call the accuracy of proxy disclosures into question. And finally, it remains unclear “whether a stockholder — who makes an inspection demand but does not file suit until after the corporation loses possession, custody, and control [of the relevant books and records]” which may be the case in a change-of-control merger, “loses standing to later file the action.” Litterst v. Zenph Sound Innovations, Inc., No. 7700-ML, 2013 Del. Ch. LEXIS 251, at *14 (Del. Ch. Sept. 30, 2013).

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