Inter-Tel, the Delaware Courts, and the Erosion of Another Pro-Shareholder Doctrine

Delaware courts often use language that suggests rigorous enforcement of corporate governance standards.  The courts are, for example, fond of quoting the language from Guth v. Loft, Inc., 5 A.2d 503 (Del. 1939) that the duty of loyalty "requires an undivided and unselfish loyalty to the corporation."  Yet the practice is quite different from the rhetoric.  The Delaware courts have reduced the duty of loyalty to a procedural test, rendering substantive fairness and the terms of the transaction largely irrelevant.  We discuss this in the article here. 

Another source of rhetoric is Blasius Industries, Inc. v. Atlas Corp., 564 A.2d 651  (Del. Ch. 1988).  Mostly a paean to shareholder rights, the decision concluded that where the board acts in a manner that interferes with shareholders' voting rights, there must be a "compelling justification."  The standard, often repeated, suggested that  the Delaware courts would go out of their way to protect the franchise. 

But some judges lost patience even with powerful rhetoric.  In Mercier v. Inter-Tel, 929 A.2d 786 (Del. Ch. 2007), Vice Chancellor Strine addressed the compelling justification test.  As he pointed out, courts had already tried to minimize the strong standard.  "Blasius is so strict a test that it is 'applied rarely.'"  But marginalization was not good enough.  He proposed complete abandonment of the test, replacing it with a reasonableness standard.  For anyone worried that this was too lose of a standard, there was no reason to worry.  Faith could be placed in the Delaware courts. "The answer to that, of course, is that the powers of equity can police manipulative behavior of that kind if it transpires."  

 At the same time, aware that his approach may not carry the day (the Delaware courts do love strongly worded pro-shareholder language even if they rarely apply it), he provided the seeds for further limitations in the "compelling justification" standard.  "Blasius seemed to suggest that its reasoning applied to all stockholder votes, not just those involving the election of directors. But the reasoning of Blasius is far less powerful when the matter up for consideration has little or no bearing on whether the directors will continue in office." (footnote omitted). 

Indeed, the objection was based on the potency of the standard.  "Frankly, I do not believe that this test should be used as to director conduct not affecting either an election of directors or a vote touching on matters of corporate control. This test is a potent one that should not be used in garden variety situations, when more traditional tools are available to police self-dealing or improperly motivated director action." (footnote omitted).  

That a board might need to sometimes reschedule a meeting is, without a doubt, appropriate.  But to do so where the board canceled the meeting solely because it expected to lose the vote and did not accurately set out the reasons for the cancellation in the subsequent notice is to provide the board with one more weapon to limit the franchise of shareholders.  Replacing the rhetoric of compelling justification with reasonableness is all but an admission that this will occur.  

Already there is some effort to have federal law control the voting process.  The access proposal set out by the Commission would make a meaningless state law right meaningful.  With decisions like Inter-Tel, the likelihood of federal intervention increases. 

Comments

[Steve]

It's important to remember that the Inter-Tel board's actions were validated as the situation played out (i.e., ISS and large stockholders changed their minds). I don't think the postponement itself caused the changed outcome. You can look at Lear for a good example where the meeting was postponed and the merger consideration was increased, yet the stockholders still voted no. Query whether VC Strine would have been as kind in Inter-Tel if the stockholders had defiantly rejected the merger at the rescheduled meeting.

The key to Inter-Tel is the (unknown) extent to which the court relied on the various factors cited by the board in support of the postponement.

It would also do great service to Delaware corporation law to have some real consistency in the standard of review. The cases dealing with adjournments, postponements, and the like vary in applying Blasius, Schnell, and the business judgment rule. The Inter-Tel proposal would drop the standard significantly, but it's not the bare rationality standard of the business judgment rule. "Reasonableness" is employed under the Revlon standard and arguably works well (or at least, directors still trip on it---see Netsmart).

And for the last time, it's "Vice Chancellor" Strine. Bill Chandler is the "Chancellor."

Glad to have your Delaware commentary back!