Portnoy v. Cryo-Cell: Vote Buying, Manipulation of the Voting Process, and the Race to the Bottom (Part 2)
We are discussing Portnoy v. Cryo-Cell, CA No. 3142-VCS, Del. Ch., Jan. 15, 2008, a 73 page tome written by VC Strine. Primary materials, including the case, can be found at the DU Corporate Governance web site.
Plaintiff challenged a number of actions by management. Among other things, he contended that the inclusion of Filipowski (a large shareholder) in the management slate violated the board's fiduciary duties. The director was added not because it was in the best interests of shareholders but because of an entrenchment motive.
The court conceded that the board did not seem particularly independent. As the opinion noted, Plaintiff "rightly portrays [the board] as having every appearance of largely following [the CEO's] lead without much question."
Filipowski apparently did not meet the board's own qualifications. The board had in place a profile setting out qualifications for new board members and had indicated that it was "unanimous in our belief that this profile is a requisite." Filipowski, however, did not meet the standards in the profile. See Id. ("This focus on Filipowski was somewhat of a reversal for the board because, as defendant Christian admitted at trial, Filipowski did not fit the board's required profile.").
Moreover, VC Strine agreed that the arrangement "fits comfortably, as a linguistic matter, within the traditional definition of so-called "vote buying" used in our jurisprudence." As he noted: In this case, I have no doubt that the voting agreement between the Filipowski Group and the incumbents was only assented to by Filipowski after he was offered a candidacy on the Management Slate."
VC Strine's vote buying characterization as a "linguistic matter" was, of course, a sign of what was to come. Much like his decision inInter Tel (which he cited as authority in this case) when he found inapplicable the compelling justification standard in disenfranchisement cases and allowed management to postpone a meeting mostly because it knew it was losing, VC Strine decided that the traditional standard of "intrinsic fairness" for vote buying was inappropriate. As he noted:
- Subjecting an agreement to add a potential insurgent to a management slate to the Schreiber intrinsic fairness test would, in my view, be an inadvisable and counterproductive precedent. If one takes a judicial standard of review seriously, as the members of this court do, the decision to subject all such arrangements to the entire fairness standard could result in creating litigable factual issues about a large number of useful compromises that result in the addition of fresh blood to management slates, new candidates who will tend to represent actual owners of equity and might therefore be more independent of management and more useful representatives of the interests of stockholders generally.
His rational seemed to be that the shareholders could correct the problem by not electing the director. "Given that the electorate's own opportunity to decide for itself whether Filipowski should serve, I think it unwise, as a matter of our common law, to apply the intrinsic fairness test to this situation." Since as even VC Strine notes, the management slate almost always wins, he is essentially concluding that a guaranteed position on the board in return for guaranteed votes is not subject to challenge.
Moreover, any reliance on shareholder approval could only be credible if there was full disclosure. Yet VC Strine's decision ignored the incomplete disclosure about the arrangement. As he noted:
- "Although it was not publicly disclosed that Filipowski's agreement to vote for the Management Slate had been conditioned on his addition to that Slate, and that the incumbents had added Filipowski to the Management Slate in exchange for his support, that inference was, I think, unmistakable to any rational stockholder."
He failed to mention, however, that the company also apparently did not disclose that Filipowski did not meet the board's own criteria for board membership as set out in the profile. (It was not mentioned in theproxy materials noting his addition to management's slate or the current report on form 8-K disclosing the arrangement.) In other words, there was at least an argument that, in order to buy the support of Filipowski's shares, the board accepted a candidate that did not meet its own qualifications. While VC Strine was comfortable with the choice ("In other words, I have no doubt Filipowski was added to the Management Slate primarily to secure his vote. But I also have no doubt that CEO and the board determined that Filipowski was a credible candidate with some useful attributes.") it was not his to make, but shareholders.
The opinion, therefore, seeks to reduce the standard of review for some types of vote buying, facilitating the practice. He apparently considers it unimportant that a board chose to disregard its own standards for board membership, something that does not bode well for shareholders who submit nominees to boards under advance notice bylaws. He likewise relies on the authority of shareholders to correct any deficiencies, noting but otherwise ignoring the usual inevitability of management's victory (for the dismal statistics on how often shareholders engage in and win contests, gohere) and declining to ensure that shareholders receive complete disclosure.
When Delaware courts purport to adopt meaningful standards for review of actions that potentially harm shareholders (disenfranchisement, vote buying, anti-takeover tactics), the courts can be counted upon to weaken the standards and ultimately allow management enormous discretion to engage in these actions. This is an example of this practice underway.