Delaware's Top Five Worst Shareholder Decisions of 2007

As the year comes to an end, we review the decisions issued by the Delaware courts.  These are the decisions that most show the anti-shareholder, anti-plaintiff nature of the Delaware courts and reflect the race to the bottom.  We have many choices, but the five that most fit this criteria are discussed below.  We encourage readers to submit comments on cases that they believe ought to go into the top 5.

#5  Openwave Systems v. Harbinger Capital Partners, 924 A.2d 228 (Del. Ch. 2007).  The case illustrates just how difficult it is for shareholders to put someone on the board over the opposition of management.  For a post on the decision, go here.   

In this case, shareholders succeeded in electing a director over management's opposition.  The Chancery Court overturned the election, finding that the shareholder (labeled a hedge fund, never a good sign for plaintiff) violated an advance notice bylaw.  The bylaws, however, were poorly drafted and conflicted with each other.  Moreover, the meeting date (Jan. 17) was only announced on December 1, with plaintiff submitting the nominees on December 28.  The relatively short time for scheduling the meeting, the confusion in the bylaws, and the fact that one of the nominees got the most votes of all candidates, made no difference to the court.    

#4  Highland Select Equity Fund, L.P. v. Motient Corp., 2007 Del. Ch. LEXIS 37 (Del. Ch. March 14, 2007), aff'd, 2007 Del. Lexis 157 (Del. Apr. 4, 2007).  The case illustrates the many barriers thrown up by the Delaware courts to the exercise of inspection rights. 

In this case, plaintiff, a large shareholder, sought to invoke its inspection rights.  The shareholder wanted to investigate mismanagement, an obvious proper purpose.  The court acknowledged that the shareholder had provided "credible evidence at trial" to support the purpose but nonetheless denied the right to inspect, finding that the shareholder in fact had an improper purpose.  The decision was remanded by the Supreme Court questioning the reasoning of the decision. 

On remand, the Chancery Court again found that the shareholder had an improper purpose.  The evidence?  Primarily the length of the demand letter.  "The starting point of this analysis is a demand letter that suffers from such extreme overbreadth that it is impossible to conclude that it was drawn in a good faith effort to comply with the clear, controlling authority of the Delaware Supreme Court. That letter spanned 25 single-spaced pages and included 47 categories requiring the production of 'all books, records, documents, and correspondence in the Company's possession, custody, or control that constitute, identify, analyze, discuss, evaluate, consider or address' a wide variety of issues."  There were other reasons, none any more valid.  The case illustrates that even when a shareholder agrees to submit to the costs associated with inspection rights, the time delay involved, and has a proper purpose, Delaware courts can still find a way to deny it the right to inspect.   

#3  Mercier v. Inter-Tel, 929 A.2d 786 (Del. Ch. 2007), a decision providing directors almost carte blanche to reschedule a meeting whenever they are losing.  Posts on this case can be found here and here. 

The case arose where management submitted to shareholders a proposed merger.  As the proxies came in, management could tell that the merger would be defeated.  A committee of the board opted to reschedule the meeting and change the record date.  They did so even though shareholders were voting against any adjournment in the event that the merger lacked sufficient votes for approval.  See 929 A.2d at 804 ("As an initial matter, I acknowledge the fact that, at the SEC's prodding, Inter-Tel included on its proxy ballot a proposal regarding whether or not to adjourn the special meeting if there were not sufficient votes to approve the Merger and that a majority of Inter-Tel's stockholders voted against an adjournment."). 

The change in the meeting date allowed management more time to lobby shareholders.  The change in the record date allowed arbitrageurs and other short term investors to have a vote in the ultimate outcome.  Without separating the two issues, the court concluded that management merely needed to show that its decision was reasonable.  Reasonable meant that management believed approval of the merger was in the best interests of shareholders.  Of course, the mere fact that the directors submitted the matter to shareholders was evidence that they believed it was in the best interests of shareholders.  The case, therefore, stands for the proposition that anytime management is losing a vote on something it submitted to shareholders, it will invariably be "reasonable" to reschedule the meeting.  This places in the hands of management enormous authority to manipulate the voting process.  

#2     Desimone v. Barrows, 924 A.2d 908 (Del Ch 2007).  This decision is a poor one for many reasons, both on the merits and for its efforts to make backdating just another form of executive compensation. 

This decision refused to allow a backdating case to go forward despite statistical evidence indicating that the practice had occurred.  The vice chancellor writing the opinion engaged in shameless dicta setting out potential justifications for backdating and the use of spring loaded options.  The case is full of hypotheticals, none of which are directly relevant to the case.  Fortunately, the opinion has not been followed in subsequent chancery court decisions.  For posts on the case, go here, here, here, and here. 

#1   While we could have come up with a number of other cases in our ranking, the worst offender goes to the use by the members of the Delaware judiciary of opinions and external speeches to expound upon matters of corporate governance that could appear before the courts or reflect a judicial predisposition.  We note as an example VC Strine's willingness to comment on multiple aspects of corporate governance, including his views on shareholder activists and his use of dictum in Desimone to comment on backdating, including the use of hypotheticals.  It is clear that some members of the judiciary enjoy the spotlight.  Nonetheless, as we have noted, this involves an inappropriate judicial disposition and transforms them into another interest group involved in the corporate governance debate, something that will ultimately make federal preemption of state law principles easier. 

Comments

[Francis Pileggi]

I respectfully disagree with the good professor and offer a "counter-list". Below is a list of 5 cases from the Delaware Court of Chancery in 2007 that demonstrate that Delaware does respect shareholders' rights and takes very seriously the duties of directors.
Sample v. Morgan, 2007 WL 177856 (Del. Ch., Jan. 23, 2007), where the court chided directors for being mere “unwitting and uninformed accomplices” in a plan to enrich other directors. The court rejected the argument that shareholder ratification had “cleansed” the transactions, and much of the reasoning relied on by the court was based on the following principle: “Every corporate action must be twice-tested: first, by the technical rules having to do with the existence and the proper exercise of power; second, by equitable rules applicable to fiduciaries.” See link for longer summary and copy of opinion:

http://www.delawarelitigation.com/2007/01/articles/chancery-court-updates/directors-wacked-for-lack-of-independence/

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In Melzer v. CNET Networks Inc., 2007 WL 4146237 (Del. Ch., Nov. 21, 2007), the Chancery Court determined that a shareholder was entitled to books and records for a period of time prior to the date of stock ownership in order to allow for the detail necessary to plead a sustained and systemic failure of oversight by the Board as described in the Caremark case. See this link for longer summary and a copy of the case: http://www.delawarelitigation.com/2007/11/articles/chancery-court-updates/its-back-to-cali-for-company-losing-demand-for-records-case-under-section-220/

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In Re: infoUSA, Inc. Shareholders Litigation, 2007 WL 2332543 (Del. Ch., Aug. 13, 2007) (revised on Aug. 20, 2007). In this Chancery Court decision, which serves as a litigator’s guide on how to successfully plead a derivative case to challenge allegedly excessive executive compensation, the court allowed a claim for excessive compensation to proceed. In explaining how such a claim should be presented, as well as explaining the best way to plead a breach of fiduciary duty claim, the court explained that “a skilled litigant and particularly a derivative plaintiff, recognizing the institutional advantages and competency of the judiciary reflected in our law, places before the court allegations that question not the merits of a director’s decision, a matter about which a judge may have little to say, but allegations that call into doubt the motivations or the good faith of those charged with making the decision.” (emphasis added).

The court’s decision included a classic quote that emphasizes why the business judgment rule is not a “blank check.” The court stated that “the rule does not require the court to bless the conclusion of a director that is self-evidently nonsense on stilts, nor does it protect a board that looks into the sun and names it the moon.” Moreover, the court continued: “Where, as here, the directors sought shareholder approval of an amendment to a stock option plan that could potentially enrich themselves and their patron, their concern for complete and honest disclosure should make Caesar appear positively casual about his wife’s infidelity. See link for longer summary and copy of decision:

http://www.delawarelitigation.com/2007/08/articles/chancery-court-updates/excessive-executive-compensation-looting-claim-allowed-to-proceed/

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In Re Netsmart Technologies, Inc. Shareholders’ Litigation (Del. Ch., March 14, 2007). In this Chancery Court decision, involving a private equity deal that certain shareholders sought to enjoin, the Chancery Court ruled: (i) the board did not have a reasonable basis for failing to undertake any exploration of interest by strategic buyers; (ii) the plaintiffs established a probability that the proxy is materially incomplete because it failed to disclose projections used to perform a discounted cash flow valuation that supported the fairness opinion. However, the court merely enjoined the merger vote until more information was disclosed. See link for longer summary and copy of opinion:

http://www.delawarelitigation.com/2007/03/articles/chancery-court-updates/delaware-chancery-court-on-private-equity-deals/

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In Valeant Pharmaceuticals International v. Jerney, 2007 WL 704935 (Del. Ch., March 1, 2007), the Chancery Court ordered the return of an excessive bonus based on a failure of the former director and president to prove the entire fairness of the decision resulting in a payment being paid to him in the amount of $3 million. See link for longer summary and copy of decision: http://www.delawarelitigation.com/2007/03/articles/chancery-court-updates/delaware-chancery-court-orders-return-of-excessive-bonus/

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Francis Pileggi

www.delawarelitigation.com