Preemption of Delaware Lawhttp://www.theracetothebottom.org/preemption-of-delaware-law/en-US2009-01-08T22:17:23ZSquarespace Site Server v5.0.0 (http://www.squarespace.com/)Delaware Courts and the Influence of Federal Preemption (part 4)http://www.theracetothebottom.org/preemption-of-delaware-law/delaware-courts-and-the-influence-of-federal-preemption-part-3.htmlJ. Robert Brown2008-12-16T21:00:36ZAre there other examples of a reduced managerial bias? Lyondell is another possibility. In that case, the Chancery Court held that the waiver of liability provision did not apply to the alleged conduct (approval of a merger involving a 45% premium). The decision caused a stir, with plenty of criticism. Essentially, the case stood for the proposition that directors without conflicts of interest might be liable for failing to take sufficient steps to protect the interests of shareholders.

Some view the case as a tempest in a teapot. Even the Vice Chancellor who wrote the opinion went to great lengths to minimize the significance of the decision (largely blaming the defendants for the result). Nonetheless, the case did breath life into the idea that directors could be liable for falling below a modest standard of behavior designed to protect shareholders. The explanation may be judicial pique but it also may be concern over federal preemption.

]]>Delaware Courts and the Influence of Federal Preemption (part 3)http://www.theracetothebottom.org/preemption-of-delaware-law/delaware-courts-and-the-influence-of-federal-preemption-part-2.htmlJ. Robert Brown2008-12-16T17:15:00ZWe are discussing whether we will see, as we did in the aftermath of SOX (take a look at footnote 382 in The Irrelevance of State Corporate Law in the Governance of Public Companies), a shift in the Delaware courts that suggests it will temporarily reduce its pro-management bias in an effort to head off possible federal preemption.

This summer, a Delaware court actually struck down bonuses paid to executive officers. Rather than apply the business judgment rule, the court subjected the payments to the "entire fairness" standard. Julian v. Eastern States Development, Civil Action No. 1892-VCP (Del. Ch. July 8, 2008), involved a dispute among three brothers conducting business together. Two sat on the board of Benchmark and, after a meeting of “less than a half an hour” attended by “no legal or financial advisors,” they voted themselves substantial bonuses. In the ensuing litigation, the directors had the burden of showing the fairness of the payments.

The directors argued that bonuses were ordinary and that the amounts were in return for the company’s “good year.” The court conceded a preexisting practice of paying bonuses but viewed the amounts as uncharacteristically large.

From 1999 through 2004, [Company's] bonuses as a percentage of adjusted income hovered between 3.30% and 3.36%. In contrast, the challenged 2005 bonuses constituted 22.28% of adjusted income. Additionally, 2005 marked the first time [the non- brother director] received a bonus beyond the performance-based compensation set forth in his Employment Agreement.

These amounts were not sufficiently explained by the company’s “good year.” “Regarding the reward for a good year, Benchmark had a better year in 2004 than 2005, and the bonuses in 2004 were still only 3.36% of adjusted income." The court held that the board had not met its burden of showing fairness.

In other words, the Delaware court merely made the board justify the payments. Had the court applied the more standard approach (the business judgment rule), it would merely have asked whether the board was informed. Based on the absurdly low standards set out in Disney, these same payments likely would have been upheld. In other words, the Delaware courts use the business judgment rule to shield unfair payments made to fiduciaries. But at least in Julian, the court had the temerity to apply modest but meaningful standards to the board of directors in connection with executive compensation. Perhaps this portends a shift in the law in Delaware, one that will entail a return of an examination of fairness to the determination of executive compensation. Or, perhaps, the decision is nothing more than an attempt to head off federal preemption in the area.

]]>Delaware Courts and the Influence of Federal Preemption (part 2)http://www.theracetothebottom.org/preemption-of-delaware-law/delaware-courts-and-the-influence-of-federal-preemption-part.htmlJ. Robert Brown2008-12-16T13:15:18ZAs an example, lets take a quick look at Oss v. Ross, 2008 Del. Ch. LEXIS 175 (Del. Ch. Nov 26, 2008). This was not a traditional corporate law case but a derivative suit for breach of fiduciary duty by the Board of Trustees of a Delaware statutory trust. What we found interesting was footnote 43 and the discussion of Section 144 of the Delaware Corporate Code. Section 144 is the provision that deals with the voidability of interested transactions. Approval by shareholders or disinterested directors will result in the transaction not being voidable.

Delaware courts have used this language to go well beyond voidability. A number of suits have found that conformity with Section 144 results in the application of the business judgment rule. Thus, approval by disinterested and independent directors under Section 144(a) results in the application of the business judgment rule. See Oberly v. Kirby, 592 A.2d 445, 466 (Del. 1991)("First, section 144 allows a committee of disinterested directors to approve a transaction and bring it within the scope of the business judgment rule."). Subsequent cases repeated the dictum. See Cinerama, 663 A.2d 1156, 1170 ("In Oberly, even though Section 144(a) did not apply to the action being contested, this Court relied upon the provisions in that statute to illustrate the general principle that, as to the duty of loyalty, approval of a transaction by a board of which a majority of directors is disinterested and independent 'brings it within the scope of the business judgment rule.'"). The same has been found true of shareholder approval under Section 144(a). See Ryan v. Lyondell Chem. Co., 2008 Del. Ch. LEXIS 105 (Del. Ch. July 29, 2008)("Ratification in those instances is governed by statute, 8 Del. C. 144, and the effect of a fully-informed vote of the shareholders is to sustain the protections of the business judgment rule.").

There are several problems with this. First, Section 144 says nothing about the standard of review. It merely renders a transaction not voidable. Second, the Section says nothing about approval by disinterested and independent directors. By its terms, the transaction is limited to disinterested director approval (because it was dealing with voidability not the standard of review). The courts have nonetheless used the provision to justify the application of the business judgment rule to conflict of interest transactions that are approved by a majority of independent and disinterested directors. By relying on Section 144, they have not taken any steps to require elimination or sterilization of the conflict of interest from the approval process.

Thus, for example, in the area of executive compensation, the CEO can participate in the debate and even vote on his/her compensation. So long as the compensation is approved by a majority of independent and disinterested transactions, it is subject to the business judgment rule. This is more than speculation. CEOs appear to be