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Thursday
Dec262013

A Management Friendly Philosophy Applied to Management Disputes: Klaassen v. Allegro Development (Part 3)

We are discussing Klaassen v. Allegro Development.

In Klaassen, the Vice Chancellor declined to overturn the decision by the non-management directors to terminate the CEO.  In doing so, the Vice Chancellor declined to find that the non-management directors erred by failing to provide notice of the plan to terminate the CEO.  The case is on appeal.

The management friendly nature of Delaware dictates that its Supreme Court will either reaffirm (or at least not overturn) the obligation of boards to notify the CEO in advance of an impending termination.  The Court will affirm (or at least not overturn) the obligation to provide this notice irrespective of the percentage of shares owned by the CEO.  In other words, the aftermath of the opinion will be that CEOs are entitled to advanced notice of their termination. 

This approach will effectively prevent boards from removing the CEO as a fait accompli.  As a result, the instances of CEO removal will decline.  In some cases, the obligation to inform the CEO in advance and the unwillingness to confront the CEO’s disapprobation, will cause the board to reconsider.  In other cases, the CEO will have the ability to call a shareholders meetings and/or lobby the weak links in any group of directors favoring removal.

Characterizing the right to notice as mandatory (that renders the meeting and act of removal void) is the most management friendly.  At the same time, however, this would essentially amount to a categorical rule.  This categorical rule requiring notice favors management but there may rare cases where it does not. 

By treating the failure to give notice as a voidable act, the courts retain some discretion.  Moreover, the discretion can be exercised in a management friendly manner.  At the same time, the discretion needs to be narrow so that CEOs know that in Delaware they can usually count on a right to advance notice of any termination.  CEOs will know that in Delaware, there can be no secret coups.    

So how will the case come out?  Based upon the race to the bottom, the Court will likely affirm the equitable nature of the notice requirement, specify that it is subject to equitable defenses, and make clear that the defenses are to be narrowly applied.  As to the actual decision in Klaassen, any prediction is a bit more problematic.  The Supreme Court in Delaware may change the reasoning of a lower court opinion but they are often hesitant to actually reverse.  Take a look at the way the Supreme Court in Axcelis completely rewrote the reasoning of the lower court but found a way not to reverse.  The facts in Klaassen provide room for this.  The CEO in that case waited a relatively lengthy period before challenging his dismissal.  This may be sufficient for the Court to be unwilling to disturb the Chancery Court’s findings in connection with the application of equity.

But, to go out on a limb, we predict that the Court will not just tamper with the reasoning but will actually reverse the Chancery Court opinion.  The case was written by a Vice Chancellor that has shown significant independence.  Indeed, the decision in Klaassen was to uphold the dismissal of a CEO by a non-management board.   

Moreover, under the race to the bottom, management has incentive to find jurisdictions with favorable law.  Favorable law generally means reduced liability for management, greater discretion with respect to their decision making, and limited ability of removal.  Reversing a decision that permitted removal of the CEO without advance notice will be an outcome that management will see has highly favorable.  

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