Delaware's Top Five Worst Shareholder Decisions for 2009 (#3): City of Estland v. Axcelis Technologies

In the discussion over shareholder access -- the right of shareholders to include their nominees in the company's proxy statement -- opponents have often pointed to majority vote provisions as if their existence somehow eliminated the need for access.  Majority vote provisions are, as we have noted, a myth.  They entail no additional authority for shareholders.  Instead, they augment the board's authority by allowing them to decide whether or not to retain a particular director. 

As much as we have tried on this Blog to demonstrate that, with respect to majority vote provisions, the emperor has no clothes, it was the Delaware Chancery Court that made the point in the most unequivocal language.  City of Westland v. Axcelis was an inspections right case.  Axcellis had in place a majority vote provision.  Shareholders successfully denied a majority to the three directors running for election.  The directors dutifully submitted their letters of resignation.  The board, however, rejected the resignations, allowing the directors to remain on the board.

Shareholders sought to inspect the records to better understand the basis for the board's decision.   They asked for minutes and agendas of meetings where the matter was discussed and any documents considered by the board in connection with its decision.  The request was hardly a fishing expedition.  It was narrowly tailored and, assuming the board acted in an informed manner, was not likely to produce anything that could be used in a subsequent derivative suit.

Nonetheless, the request ran head long into the Delaware court's use of excessive pleading standards to deny inspection rights.  It wasn't enough that the decision by the board directly implicated shareholder voting rights.  Shareholders had to present credible evidence of wrongdoing even to be able to inspect the minutes and examine the agendas. 

Needless to say, the Delaware Chancery Court found that shareholders had not met this burden.  The decision effectively meant that directors could be assured of complete secrecy in considering letters of resignation, effectively rendering their decisions unreviewable.  To the extent that directors declined to accept resignation letters for self serving reasons (they would expect the same treatment if they ever failed to receive majority approval),  they would know that shareholders would be denied any opportunity to explore these motives.  In effect, therefore, the board's authority with respect to resignation letters was not bounded by fiduciary obligations.  The analysis alone demonstrates the meaningless nature of majority vote provisions.

Yet if the point were not clear enough, Vice Chancellor Noble made it even more unequivocally. 

• The Three Directors were properly reelected to the Board under Delaware corporate law’s plurality voting provisions. With this fact the Plaintiffs do not, and cannot, disagree. However, because a certain number of shareholders withheld their votes, a Board-enacted governance policy was triggered requiring each of the Three Directors to submit their resignation to a Board designated committee, which would then recommend whether the Board should, it its sole discretion, accept the resignations. The Plaintiff argues that a sufficient number of shareholders withheld their votes in reliance on, and out of a desire to trigger, the Policy. If so, they were successful; these shareholders achieved their desired goal and the Policy was triggered.  The problem for the Plaintiff is that the Policy vested discretion whether to accept the resignations of the Three Directors in the Board. By refusing to accept these resignations, the Board effectuated the results of a valid shareholder election. There is no evidence that the Board identified, and then sought to thwart, the will of the shareholder franchise by refusing to accept the resignations of the Three Directors.

Of course, the conclusion that there was "no evidence" that the board sought to thwart the will of shareholders was wrong, both legally and practically.  Legally shareholders alleged that the company misstated the reasons for declining to accept the resignations.  Practically, the shareholders as a group voted to oust the directors from the board.  It smacks of a trip through the looking glass to then say that the rejection of this clear intent doesn't thwart the will of shareholders.

But in any event, none of this amounted to credible evidence, allowing the court to dismiss the request for minutes and agendas. 

• Merely pointing out the Board’s exercise of discretion under the Policy—an exercise which ultimately effectuated the shareholder franchise—is not credible evidence of wrongdoing on this record. The Three Directors took office, duly elected by a plurality of Axcelis shareholders. The ultimate result under the Policy was the result of the shareholder franchise, not an interference with it. Absent the Policy, the result of the May 2008 election would have been no different.

It was, in the end, the use of excessive pleading standards to deny shareholders a modest amount of information on a topic of unquestionable importance. 

The case is on appeal so there is some chance that the Delaware Supreme Court will fix the result.  Given the Court's reasoning in Seinfeld, however, that is unlikely.  Like so much in Delaware, the true fix will need to be federal.  With the SEC increasingly using disclosure to alter the corporate governance balance, it will need to adopt another amendment to the Form 8-K to require disclosure in this area. 

In short, rather than allow inspection rights to be an occasional source of additional information for motivated shareholders, the Delaware courts will cause the federal government to impose disclosure obligations on all public companies.  It is increasingly the consequence of the Delaware approach to decision making in the corporate governance area. 

Primary materials on this case can be found at the DU Corporate Governance web site.