The Race to the Bottom and "Fodder for those Who Seek a Federal Takeover of Delaware Corporate Law"

The debate on Blogging and its role in the academy is an ongoing one.  Nonetheless, it seems clear to The Race to the Bottom that blogging can play an important role on the continuum of scholarship.  It provides a mechanism for commenting on legal developments on a semi-real time basis.  As a result, the commentary can influence the debate as it happens.

With that in mind, we turn to San Antonio Fire & Police Pension Fund v. Amylin Pharmaceuticals, a case we have written about extensively on this Blog.  It is a poster child for preemption and explains why Delaware cannot be trusted with the residual authority to determine the duties of directors.  The case involved poison puts.  To the extent shareholders voted for directors that resulted in a change in control, outstanding debt could be put back to the company.  With the debt trading at a fraction of its face amount, the put threatened to financially ruin the company.

The impact on voting was clear enough.  No rational shareholder would favor a change in control if it meant bankrupting the company.  The issue was whether the put violated fiduciary duties.  The Chancery Court found that the board had not known about the put and, as a result, had no duties.  The opinion lectured outside counsel on the need to inform the board of these types of things but resolutely declined to impose an affirmative obligation on directors to know about or consider these types of provisions.  In short, the court reaffirmed that when it came to depriving shareholders of their voting rights, directors could remain ignorant and unimformed. 

Well, our criticism made it into the litigation, albeit in a backhanded way.  Appellants included the following in the public version of their brief:

• The Court of Chancery’s Opinion offers no redress for a pressing corporate governance failure and it radically departs from Delaware precedent protecting the stockholder franchise. That result justifies reversal in any circumstances. Given the pendency of federal legislative and regulatory proposals respecting director elections, reversal is especially urgent. Last week, the Delaware State Bar Association sent an unprecedented comment to the Securities and Exchange Commission arguing for maintaining the primacy of Delaware law, especially in light of recent amendments to the Delaware General Corporation Law and the “significant equitable limitations on the power of the board of directors to frustrate stockholder electoral efforts.” The Court of Chancery’s Opinion imposes no “significant equitable limitations” on Proxy Puts. To the contrary, the Opinion’s failure to scrutinize board action that frustrates proxy contests provides fodder for those who seek a federal takeover of Delaware corporate law.4 

And Footnote 4, the "fodder for those who seek a federal takeover of Delaware corporate law?"  None other than The Race to the Bottom.   Here is the text:

• See J. Robert Brown, Poison Puts, Shareholder Voting Rights and the Need forn Even Stronger Shareholder Bill of Rights: San Antonio Fire & Police v. Amylin Pharmaceuticals (Introduction) (May 28, 2009), http://www.theracetothebottom.org/shareholder-rights/ (“[A]s long as the case remains good law, it provides yet another reason for federal preemption and expansion of the Shareholder Bill of Rights…. The case provides management with a mechanism for deterring and/or winning any proxy contest”).

There is no question that the current waive of preemptive efforts is directly related to the failing of Delaware courts to give fiduciary duties any meaningful content.  Much of the current debate focuses on executive compensation, with Disney the hallmark of the dismal standard accepted in the jurisdiction.  Likewise, the refusal to require boards to engage in meaningful oversight of risk best articulated in In re Citigroup has resulted in legislative and impending regulatory proposals that would mandate risk review, including during the compensation determination process.  

Amylin goes the furthest.  It, more than any other case, shows that the board had an incentive not to know what is going on.  Without an obligation to know about the poison puts, they become all but unreviewable despite their disenfranchising effect.  Can there be any better example of why Congress needs to take over and federalize the information reporting system for the board?  Some of that was done in SOX by requiring financial reporting systems and their assessment by outside auditors (remember the fierce debate over Section 404?).  This now needs to be expanded to define far broader categories of information, including those that would result in effective disenfranchisement of shareholders. 

It is unfortunate that the basic obligation of a board to be informed needs to be federalized but, given the state of the law in Delaware, it does. 

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[Toronaga Shogun]

Weak judges make bad law. Judges with political or philosophical agendas do the same.