Opinion ID: 2275517
Heading Depth: 1
Heading Rank: 11

Heading: Corporate Governance Review Standards

Text: The defining tension in corporate governance today has been characterized as the tension between deference to directors' decisions and the scope of judicial review. [12] The appropriate standard of judicial review is dispositive of which party has the burden of proof as any litigation proceeds from stage to stage until there is a substantive determination on the merits. [13] Accordingly, identification of the correct analytical framework is essential to a proper judicial review of challenges to the decision-making process of a corporation's board of directors. [14] The business judgment rule, as a standard of judicial review, is a commonlaw recognition of the statutory authority to manage a corporation that is vested in the board of directors. The business judgment rule is a presumption that in making a business decision the directors of a corporation acted on an informed basis, in good faith and in the honest belief that the action taken was in the best interests of the company. [15] An application of the traditional business judgment rule places the burden on the party challenging the [board's] decision to establish facts rebutting the presumption. [16] The effect of a proper invocation of the business judgment rule, as a standard of judicial review, is powerful because it operates deferentially. If the business judgment rule is not rebutted, a court will not substitute its judgment for that of the board if the [board's] decision can be `attributed to any rational business purpose.' [17] In Blasius, Chancellor Allen set forth a cogent explanation of why judicial review under the deferential traditional business judgment rule standard is inappropriate when a board of directors acts for the primary purpose of impeding or interfering with the effectiveness of a shareholder vote, especially in the specific context presented in Blasius of a contested election for directors: [T]he ordinary considerations to which the business judgment rule originally responded are simply not present in the shareholder voting context. That is, a decision by the board to act for the primary purpose of preventing the effectiveness of a shareholder vote inevitably involves the question who, as between the principal and the agent, has authority with respect to a matter of internal corporate governance. That, of course, is true in a very specific way in this case which deals with the question who should constitute the board of directors of the corporation, but it will be true in every instance in which an incumbent board seeks to thwart a shareholder majority. A board's decision to act to prevent the shareholders from creating a majority of new board positions and filling them does not involve the exercise of the corporation's power over its property, or with respect to its rights or obligations; rather, it involves allocation, between shareholders as a class and the board, of effective power with respect to governance of the corporation.... Action designed principally to interfere with the effectiveness of a vote inevitably involves a conflict between the board and shareholder majority. Judicial review of such action involves a determination of the legal and equitable obligations of an agent towards his principal. This is not, in my opinion, a question that a court may leave to the agent finally to decide so long as he does so honestly and competently; that is, it may not be left to the agent's business judgment. [18] In Blasius, the Chancellor did not adopt a rule of per se invalidity once a plaintiff has established that a board of directors has acted for the primary purpose of interfering with or impeding the effective exercise of a shareholder vote. [19] Instead, the Chancellor concluded that such situations required enhanced judicial scrutiny, pursuant to which the board of directors bears the heavy burden of demonstrating a compelling justification for such action. [20] In Blasius, the Chancellor then applied that compelling justification standard of enhanced judicial review in examining a board's action to expand its size in the context of a contested election of directors, exactly what the Liquid Audio board did in this case. In Blasius, notwithstanding the fact that the incumbent board of directors believed in good faith that the leveraged recapitalization proposed by the plaintiff was ill-advised and less valuable than the company's business plan, Chancellor Allen explained why the incumbent board of directors' good faith beliefs were not a proper basis for interfering with the stockholder franchise in a contested election for successor directors. The only justification that can be offered for the action taken is that the board knows better than do the shareholders what is in the corporation's best interest. While that premise is no doubt true for any number of matters, it is irrelevant (except insofar as the shareholders wish to be guided by the board's recommendation) when the question is who should comprise the board .... It may be that the Blasius restructuring proposal was or is unrealistic and would lead to injury to the corporation and its shareholders if pursued .... The board certainly viewed it in that way, and that view, held in good faith, entitled the board to take certain steps to evade the risk it perceived. It could, for example, expend corporate funds to inform shareholders and seek to bring them to a similar point of view. But there is a vast difference between expending corporate funds to inform the electorate and exercising power for the primary purpose of foreclosing effective shareholder action. A majority of shareholders, who were not dominated in any respect, could view the matter differently than did the board. If they do, or did, they are entitled to employ the mechanisms provided by the corporation law and the Atlas certificate of incorporation to advance that view. [21] In Blasius, the Chancellor set aside the board's action to expand the size of its membership for the primary purpose of impeding and interfering with the effectiveness of a shareholder vote in a contested election for directors. In this case, not only did the Liquid Audio board of directors take similar action in expanding the size of its membership and appointing two new directors to fill those positions, but it took that action for the same primary purpose.